The Fed has just made a major change in its monetary policy. After 17 months of the status quo, the central bank decided to cut its key rates by 0.50 percentage points at its September meeting. Ready for a print refund?
The Fed’s spectacular turnaround
The Fed’s rate cut was widely expected by markets, but its scale surprised many observers. Until the last moment, investors hesitated between a decrease of 0.25 or 0.50 points.
In the end, it was the most aggressive option that won out, a sign that the Fed is committed to supporting the economy.
This spectacular turnaround contrasts with the still-cautious tone taken by Fed officials a few weeks ago. Governor Christopher Waller made the announcement in early September “the time has come” to cut rates, but prefers a step-by-step approach.
However, the publication of articles in the press indicating the possibility of a decrease of 0.50 points changed the situation. These items have changed market expectations in favor of more easing.
A win for Powell
Decision to lower rates by 0.50 points is perceived as a personal victory for Fed Chairman Jerome Powell.
He managed to convince most of his colleagues to opt for more significant monetary easing, despite the reluctance of some members of the Monetary Policy Committee.
The decision bolsters the credibility of Jerome Powell, who has sometimes been criticized for lacking authority within the Fed. It demonstrates its ability to build consensus within the institution and promote its vision of monetary policy.
A risky bet for the Fed?
While markets welcome the rate cut, some economists are concerned the risks involved.
The Fed is betting that inflation is under permanent control and that the US economy can withstand monetary easing without inflationary overheating.
However, the latest inflation data stay above the Fed’s 2% target. The PCE index, the central bank’s preferred measure of inflation, in August it was still 2.7% over the year. As a result, some fear that rates will fall too quickly it revives inflationary pressures.
The Fed justifies its decision slowdown in the labor market. The unemployment rate rose to 4.2% in August, the highest level in nearly two years. But even here this number remains historically low and does not reflect a significant deterioration in employment.
Optimistic projections?
New economic projections published by the Fed demonstrate the institution’s optimism. The central bank now expects growth of 2.1% this year and 1.5% next yeardata were revised upwards compared to June.
primarily The Fed forecasts that inflation will continue to moderate, reaching 2.2% in late 2024 and 2% in 2025. These projections allow it to consider further rate cuts in the coming months.
It is given by the median of the forecasts of the members of the Monetary Policy Committee key rates at 4.4% at the end of 2024 and 3.4% at the end of 2025compared to the current 5.3%. This means a a cumulative decline of almost 2 percentage points by the end of 2025.
The Fed brings the printing press
Aside from the one-off decision to cut rates, the Fed’s entire doctrine appears to be evolving. The central bank appears to be adopting a more flexible and responsive approach to monetary policy.
While it has long favored gradual rate increases to combat inflation, this time the Fed decided to cut quickly and significantly. This shift reflects its desire to be more active in supporting the economy, even if it means taking some risks.
This new approach raises questions about the Fed’s ability to fine-tune the economy.
A division within the Fed
The decision to cut rates by 0.50 points was not unanimous within the Monetary Policy Committee. Gov. Michelle Bowman opposed the decreasebegging for a more gradual relaxation.
It is the first time since 2005 that a Fed governor has formally opposed a monetary policy decision. This disagreement illustrates the debates that roil the institution about the appropriate pace of rate cuts.
Michelle Bowman, appointed by Donald Trump, concerns about inflationary risks associated with too rapid easing. Her position contrasts with the position she defended during the Trump administration, where she supported accommodative monetary policy.
This turn raises questions about independence of the Fed. Some observers see the influence of political considerations, upcoming presidential elections in 2024.
Uncertainty…
The impact of this rate cut on the real economy remains uncertain. Whether to encourage investment and consumptionits impact could be limited while rates remain historically high.
Businesses and households have already largely factored the prospect of rate cuts into their decisions. Given the limited surprise effect, the economic stimulus could be less pronounced than in the past.
Some economists also worry about the potential perverse effect of this rate cut. By sending a pessimistic signal on the economic outlook, Paradoxically, the Fed could slow down activity in the short term.
Euphoric markets
Financial markets, on the other hand, enthusiastically welcomed the Fed’s decision. Wall Street ended sharply higher on Wednesday as the S&P 500 rose more than 1.5%. Bond rates fell significantly, with the 10-year yield falling below 3.9%.
This positive reaction reflects investor relief that the Fed is seen as more accommodative. But it also increases fears of new speculative bubbles forming, while stock market valuations are already high.
A drop in the dollar following the Fed’s decision could also reignite trade tensions with some of the United States’ partners, such as Europe or Japan.
Brrrrr!
The Fed made it clear that this first rate cut more will follow.
Markets now expect three more declines of 0.25 points by the end of 2024which would bring back key rates around 4.5%.
However, this scenario remains conditional on the development of the economic situation. The Fed emphasized that it will stay “data dependent”, that is, attentive to economic indicators to adjust his policy.
A sharper-than-expected slowdown in activity could therefore lead the central bank to accelerate the pace of rate cuts. On the contrary, the revival of inflation would undoubtedly force it to procrastinate.
The Fed: the most influential institution in the world?
Finally, the Fed’s decision to cut its rates by 0.50 point appears full of challenges. It marks a turning point in American monetary policy and there will be consequences outside the United States.
Its success will depend on the Fed’s ability to find the right mix between them supporting the economy and controlling inflation. A balancing act that promises to be delicate in economic and geopolitics uncertain (China, Iran, Israel, Lebanon, Ukraine, etc.).
Jerome Powell and the Fed’s credibility is at stake Their bet on a soft landing for the US economy will be closely scrutinized in the coming months. Time will tell if this historic shift in monetary policy was justified. Or if the Fed failed again. In that case, its abolition would be all the more justified, replacing it with the happy Bitcoin (BTC) standard.
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