The Federal Reserve acted as expected to lower the benchmark Fed funds rate for the first time in this cycle. Market observers had fully expected a rate cut going into the September 2024 meeting, but had been divided between a 1/4 point and a 1/2 point hike. The Fed chose to start with a larger move, which Federal Reserve Chairman characterized as a decisive recalibration towards a more neutral stance (as opposed a restrictive stance), lowering the rate by 50 basis points to a target of 4.75 to 5.00%.
While the decision was not unanimous, the Fed's large move indicates that it believes that it has largely restored price stability with inflation measurements indicating that the pandemic price burst has eased and inflation is well on its way to the Fed's 2% target.
The Fed has been somewhat reluctant to provide further guidance on additional rate moves. Bond markets is clearly pricing in at least one additional 25 basis point cut before the end of 2024 and several additional cuts in the first half of 2025.
The Federal Reserve ended its July meeting by issuing a statement that adjusted its rate stance. Whereas the Fed had previously indicated that it was principally biased towards fighting inflation, its new statement indicates that there has been real progress towards its 2% target and that it is attentive to risks on both sides of the mandate (i.e., inflation and maximum employment).
The shift to a neutral stance was well projected by Chairman Jerome Powell and the others on the Federal Reserve. It was also well anticipated. Only about 3% of economists polled believed that the Fed would cut interest rates at this meeting, and between 97% and 100% believe that the first cut would come at the September meeting.
Even though the Federal Reserve projected well and did not cut rates now, the stock market has sold off dramatically and both yields have come down sharply. Markets are acting oddly, as if the Fed sees that a recession is on the near horizon and that it will need to lower rates sharply and quickly. Treasury yields between 3 and 5 years have already fallen below 4% within 24 hours.
This panicked reaction would be odd, except for the fact that rates have hovered near 23 year highs for the better part of the last 16 months and the default mechanism for fighting recessions during that period has been to take short-term interest rates close to zero. We also have a Presidential candidate who seems to alternate between arguing that Powell has held rates too high (while insisting that if he lowers rates before November, he would be committing election interference).
But, we have been here before. In January, yields came in sharply when economists believed that the Fed was about to cut, only to reverse and move to higher levels for most of the year. My hunch therefore is that the Fed is going to move rates down very slowly and deliberately. It will only act as quickly as the yield curve is now indicating if we fall into a sharp recession.
Whether the Fed moves quickly or slowly, we have moved to a place where bank CDs are much more attractive than US Treasuries, even for those in the highest tax jurisdictions who can benefit from the tax-free attributes of the latter.
The Federal Reserve has finished its June 2024 meeting, leaving interest rates at a 5.25% to 5.50% target.
While recent CPI numbers show that the pace of inflation has declined, the Fed is concerned that more progress needs to indicate a sustained move towards its 2% target.
The Fed's decision to leave rates at current levels is guided by the fact that we have had a soft landing in the economy. While the labor market may be cooling, it isn't contracting. And, there are certainly areas of the economy that are not doing well, but many areas are booming. Since there is a stickiness to inflation, the Fed prefers to take a wait and see attitude before it lowers rates.
The majority of Fed voting members now see one cut this year, and it is unlikely that this cut will happen before its December meeting. The median targets for the Fed funds rate at the end of 2024 is 5.10%, at the end of 2025 is 4.10% and at the end of 2026 is 3.10%. The median long range target has gone up from 2.60% to 2.80%.
