By Alexander Jones, International Banker
So, after many months of speculation, the Federal Reserve Board of Governors (the Fed) in the United States finally announced its decision on September 18 to cut its benchmark interest rate—the first rate cut since all the way back in March 2020. It wasn’t just a modest 0.25-percent cut either; rather, the Federal Open Market Committee (FOMC) decided to drop its federal funds rate by a mighty 50 basis points to 4.75-5.00 percent, indicating growing confidence that the annual inflation rate will continue subsiding towards the Fed’s formal target of 2 percent. But is that confidence justified, and if so, where do rates go from here?
“Recent indicators suggest that economic activity has continued to expand at a solid pace. Job gains have slowed, and the unemployment rate has moved up but remains low. Inflation has made further progress toward the Committee’s 2 percent objective but remains somewhat elevated,” the FOMC’s statement read, reflecting on its decision to cut rates by 50 basis points. “The Committee has gained greater confidence that inflation is moving sustainably toward 2 percent and judges that the risks to achieving its employment and inflation goals are roughly in balance. The economic outlook is uncertain, and the Committee is attentive to the risks to both sides of its dual mandate.”
The Fed’s chair, Jerome Powell, meanwhile, echoed those views following the FOMC’s rate announcement, emphasising the need to bring inflation down further without inducing unnecessary joblessness. “We’re trying to achieve a situation where we restore price stability without the kind of painful increase in unemployment that has come sometimes with disinflation,” Powell acknowledged.
But given the Fed’s notorious pandemic-era mistake of failing to prevent prices from spiralling uncontrollably—largely because of Powell’s fateful assessment at the time of rising inflation as a “transitory” trend—it is certainly worth evaluating whether the 50-basis-point cut is appropriate given the wider macroeconomic conditions. Or could lightning strike twice, with the Fed’s monetary policy proving too expansionary?
A few have even suggested that the 50-basis-point cut—adopted during the final rate meeting before the US presidential elections on November 5—was politically motivated, presumably to help the Democratic candidate, Kamala Harris, secure victory. “The fact is that the Federal Reserve brought the interest rates down a little too quickly,” a certain Republican candidate, Donald Trump, recently remarked. “It was too big a cut, and everyone knows that was a political manoeuvre that they tried to do before the election.”
The minutes from the FOMC’s September 17-18 meeting also show that there was considerable internal debate over whether a 25-basis-point or 50-basis-point cut was the most suitable. And although a near-unanimous decision (Fed Governor Michelle Bowman was the sole voice for a 25-basis-point cut instead) was given for the latter in order to encourage further economic expansion amidst the easing of inflation and a potentially warming labour market, the minutes noted that several FOMC participants acknowledged that a 25-basis-point reduction “would be in line with a gradual path of policy normalization that would allow policymakers time to assess the degree of policy restrictiveness as the economy evolved”.
Nonetheless, an economic advisor to Trump during his first presidential term was more positive about the Fed’s move. “The latest move to start reducing rates is something that made a great deal of sense based on the data that they had at the time,” Kevin Hassett told the Financial Times on October 18. “It did look like there was a sharp slowing going on.” And it would appear that there is some justification for Hassett’s viewpoint, especially given that annual US inflation continued to fall in September to 2.4 percent from the 2.5 percent recorded the previous month, although this was slightly lower than the 2.3 percent predicted by analysts beforehand.
Nonetheless, with inflation continuing to ease even in the aftermath of the half-percentage-point cut, confidence is growing that rates can continue to be brought down further during subsequent FOMC meetings. According to the October 21 reading from CME FedWatch, a tool that tracks the latest probabilities of changes to the Fed rate as implied by 30-Day Fed Funds futures prices, markets are pricing in a 99.4-percent likelihood that the Fed’s next meeting scheduled for November 6-7 will see an additional 0.25-percent cut approved, bringing the federal funds rate down to 4.50-4.75 percent.
And that’s unlikely to be the end of the cuts—far from it. On October 16, Goldman Sachs said that it expected the Fed to continue trimming rates during the next few FOMC meetings, with consecutive 25-basis-point cuts likely to be approved from the November 6-7 meeting all the way through an additional five meetings and ending with the final cut administered on June 17-18, 2025, at a terminal rate of 3.25-3.5 percent.
A FOMC member and Federal Reserve Bank of San Francisco’s president, Mary Daly, also recently voiced her anticipation of more rate cuts transpiring, provided that the data is in line with the Fed’s expectations. The September cut was a “right-sizing” of the stance of interest-rate policy, “recognizing the progress we’ve made and loosening the policy reins a bit, but not letting go,” Daly said in a speech, as quoted by Reuters. Daly also noted that “even with this adjustment, policy remains restrictive, exerting additional downward pressure on inflation to ensure it reaches 2 percent”.
Some of that “data” is already defying expectations, however. According to the data from the Mortgage Bankers Association’s (MBA’s) Weekly Applications Survey for the week ending October 11, for instance, the average 30-year fixed mortgage rate had climbed to its highest level since August 9—an unexpected jump given the Fed’s rate cut just a few weeks earlier. “The recent uptick in rates has put a damper on applications. Refinance applications fell 26 percent to their lowest level since August, with comparable drops in both conventional and government refinances,” said Joel Kan, the MBA’s vice president and deputy chief economist. “This pushed the refinance share of applications back below 50 percent for the first time in over a month. Furthermore, purchase applications also decreased but notably remain 7 percent higher than a year ago.”
This seemingly odd trend is likely due to the continued rise in October of 10-year Treasury yields—of which mortgage rates tend to track more closely than they do the benchmark fed funds rate—a likely result of investors moving out of relatively safe bonds and into riskier stocks after the rate cut, pushing down bond prices and thus raising bond yields. And with mortgage lenders possibly still adding their own sizeable margins on top of market rates, mortgage rates may remain elevated for some time yet.
It thus means that potential homebuyers who may have been celebrating September’s 50-basis-point cut may have to wait a little longer to buy a house at an affordable mortgage rate. That said, with the MBA’s 30-year mortgage rate having peaked at almost 8 percent in October 2023, customers may be more enticed to enter the market now than they were a year ago, especially if they are looking to refinance any mortgages taken out in recent years at higher rates.
Should they wait, they are likely to be rewarded with several more rounds of monetary easing; although, with the Fed having only delivered its first of what many are hoping will be an extended series of rate cuts over the months, much caution and vigilance are advised to ensure mistakes of the past are not repeated. This is especially pertinent given the precariously tight labour-market environment of near-full employment that persists at present.
Indeed, in further remarks about the eventual destination of the Fed’s rate-cutting journey, Daly also acknowledged that “we’re a long way from where it’s likely to settle, so the decisions that are really in front of us are ones about how quickly to adjust” to an interest rate that’s neutral in its impact on the economy. That neutral rate, Daly added, is likely to be higher than the rock-bottom rates seen in early 2020 at the onset of the pandemic.
Others share Daly’s view of this higher neutral rate, moreover. The Fed’s own Summary of Economic Projections (SEP), which was also disclosed on September 18, for instance, showed that the median FOMC participant is anticipating 50 basis points of cuts in total for the FOMC’s remaining November and December meetings this year, followed by a total 1-percent cut during 2025 and a further 0.50-percent cut in 2026. At that point, the terminal rate of 2.9 percent will be achieved and will remain there throughout 2027, the SEP forecasted.
For some, it is the bond market that may have the final say in influencing where that neutral rate ends up. “Given the vast and growing supply of bonds markets must absorb in coming years, rates will probably be higher than they were in the years before the pandemic,” Richard Clarida, former vice chair of the Federal Reserve and global economic adviser at PIMCO (Pacific Investment Management Company), wrote in an October 14 piece for the Financial Times, also arguing that the neutral policy rate will likely be higher than its pre-pandemic 0.5 percent, but that the increase will also be modest. “But I believe most of the required adjustment will occur through the slope of the yield curve and not so much from a much higher destination for the fed funds rate itself.”