The Federal Reserve will begin a key pivot this week - cutting interest rates for the first time in more than four years - as they pursue a rare soft landing for the U.S. economy.
With inflation seemingly under control and signs of weakness in the U.S. labor market, the Fed is expected to cut its benchmark lending rate by at least 25 basis points at its two-day meeting that ends on Thursday Beijing time. In financial markets, some traders and economists at JPMorgan Chase & Co., the largest U.S. bank, are even preparing for a bigger 50 basis point cut.
This is a "defining moment" that will free the world's largest economy from a prolonged period of rising borrowing costs. The move will likely be accompanied by signals from the Fed that it is ready to provide more "relief" to American businesses and households in the coming months. This combination should maintain the momentum of the global asset revaluation that has already begun.
“This is a huge positive for Americans and the entire global economy,” said Mark Zandi, chief economist at Moody’s Analytics. “It will largely remove the pressure from the Fed on the economy and allow the economy to move forward. This has already helped, and stock prices are higher than they would have been without this situation.”
However, the path ahead for policymakers and the U.S. economy remains fraught with uncertainty. Many investors and some economists worry that the Fed has waited too long, leaving the labor market and economic growth on thin ice and injecting volatility into financial markets. The latter was evident in the U.S. Treasury market on Friday, when traders suddenly resumed betting on a 50 basis point rate cut.
November's presidential election also puts Fed policymaking in an unpleasant position, with Republican candidate and former President Donald Trump warning that the Fed should not cut rates before the election, while Democratic Senator Elizabeth Warren has pressured officials to cut rates by 75 basis points.
“This is a critical move,” said Priya Misra, portfolio manager at JPMorgan Asset Management. “Soft landings are very rare.”
JPMorgan Chase is the only one of the largest U.S. banks to stick with its call for a 50 basis point rate cut from the Federal Reserve. But while other banks have reverted to a 25 basis point cut, Michael Feroli, the bank’s chief U.S. economist, reiterated in a note to clients on Friday that a 50 basis point cut is “the right thing to do.”
Misra also wants the Fed to cut rates by 50 basis points initially, but she said a 25 basis point cut seems slightly more likely because of policymakers' concerns about the possibility of lingering inflation. If the Fed does cut rates by 25 basis points, the market reaction will depend largely on how officials "interpret" the smaller rate cut, she added.
That’s why, after the Federal Reserve cuts interest rates on Thursday, investors and analysts will be focusing on two things: the projection of the path of the Fed’s benchmark interest rate, known as the “dot plot,” and a press conference half an hour later by Fed Chairman Jerome Powell.
The forecasts will provide each policymaker’s expectations for the end of each year through 2027. They will include a glimpse, albeit anonymously, of officials’ expectations for the period between now and the end of 2024. Officials almost never provide such explicit disclosures when policy is at an inflection point, but the timing of the quarterly forecasts leaves them no choice.
“The dot plot at the end of the year, that’s becoming particularly important now,” said David Wilcox, a former head of the Fed’s research and statistics department. “It’s obviously more watched because they’re about to start a rate-cutting cycle.”
Specifically, the dot plot will show how many members of the Federal Open Market Committee have already favored further rate cuts in November and December, and how many expect one of the rate cuts to be 50 basis points. If a significant number of officials support the latter, it means the FOMC is not far from shifting to more aggressive actions.
Whatever the number, it would mark a significant change from forecasts in June, when no policymaker expected more than two rate cuts this year.
Traders are taking a more aggressive view of the future path of interest rates. Since the disappointing July payrolls report, they have been betting on a rate cut of about a percentage point by the Fed in 2024. As of Friday, they were pricing in about 114 basis points of Fed rate cuts by the end of December — including this week’s cut. By the end of 2025, they see the benchmark rate falling to 3%.
Then came Powell's face-to-face meeting with reporters.
If the FOMC starts with a cautious 25 basis point rate cut, those who believe danger is building in the labor market will want the Fed chairman to signal that officials will be ready to act more decisively if necessary. Wilcox said Powell himself may also want to keep his options open for future meetings, no matter how much they cut rates from the start.
“Any announcement — a 25 basis point cut or a 50 basis point cut — could be described as a difficult decision,” said Wilcox, who has advised three Fed chairmen. “To some extent, this could be described as a compromise.”
There are only a few soft landings.
Powell has signaled he is ready to respond if unemployment rises. In a speech at the Jackson Hole central bank symposium on Aug. 23, he said the Fed would “not seek or welcome a further cooling of labor market conditions.”
His colleague, Fed Governor Waller, was more direct on September 6. Not only did he say now was the time to cut rates, but he also made it clear that further deterioration in the labor market would provide the FOMC with a reason to "act quickly and forcefully."
The consequences of falling behind could be severe. According to former Fed Vice Chairman Blinder, the Fed has only once achieved a definitive soft landing, in the mid-1990s, and more often than not, it has triggered a recession. Leaving aside the 2020 crash, the six recessions over the past 50 years have pushed unemployment to an average of 8.6%. A similar scenario would leave millions of people jobless.
The current unemployment rate is 4.2%, significantly higher than the historic lows experienced during most of the past three years. As early as April 2023, the unemployment rate was 3.4%, but it has been rising since then and triggered the Sam Rule this summer, which usually indicates that the economy is in recession.
Michael Kelly, global multi-asset head at PineBridge Investments, isn’t predicting a U.S. recession, but he’s worried enough that he’s buying long-term U.S. Treasuries as a hedge against such an outcome.
"What we've seen before is that once the job market collapses, it collapses quickly," Kelly said. "Once the stones start rolling down the hill, it's hard to get in front of them and stop them."
Yet Powell and his colleagues are tantalizingly close to a goal that most economists considered nearly impossible to achieve after prices spiraled out of control in mid-2021, when the pandemic disrupted global supply chains. Inflation, as measured by the Fed’s preferred measure, has fallen to 2.5% in the year through July, and unemployment remains low.
When the Fed began its rate hike cycle with a modest 25 basis point increase in March 2022 and belatedly took action on inflation, few economists predicted it would get to that point unscathed. Officials then accelerated the pace of rate hikes in subsequent meetings, ultimately raising the benchmark rate target range to 5.25% to 5.5%, where it remains today. They raised rates six times in a big way - by 50 basis points or 75 basis points each time.
Any outcome other than a 25 basis point rate cut at the Fed meeting would surprise the market, but the interest rate market may take its cue from the change in the 2025 median dot plot in the Summary of Economic Projections. If the Fed's rate outlook changes, the short-term interest rate market may quickly adjust after a knee-jerk reaction to the rate cut announcement, but the biggest possibility remains that Powell will continue to "depend on the data" in his post-meeting press conference.
Along the way, the U.S. economy has proven surprisingly resilient. Unemployment even fell slightly after the Fed began raising interest rates. Job openings, which had soared during the pandemic, remain high, while price increases have remained stubbornly strong, reaching a 40-year high in the summer of 2022.
More recently, however, the economy has slowed. While layoffs remain rare, hiring has stalled, making it harder for the unemployed to find work. The job opening rate has fallen to its lowest level since 2021. At the same time, higher mortgage rates and soaring home prices have squeezed housing affordability, causing annual existing-home sales in 2023 to fall to their lowest level in nearly 30 years.
The Fed chair and other policymakers have maintained that conditions in the labor market and the economy as a whole still resemble their pre-pandemic health, and many on the committee believe that risks to the labor market are now roughly comparable to those posed by inflation.
But the FOMC is not united now. Some, such as Governor Waller and Chicago Fed President Goolsbee, worry that the employment threat is now the top priority. Others, such as Atlanta Fed President Bostic and Governor Bowman, are still worried about the resurgence of inflation.
That means everything Thursday — from the committee statement to the forecasts to Powell’s every word — will be closely watched. Investors will be looking for assurances that officials are still on track to cut rates to prevent the labor market from collapsing while eliminating inflation. Seth Carpenter, chief global economist at Morgan Stanley, said:
“This is going to require the Fed to strike a balance between the two sides of its dual mandate more than ever before, and for the markets, they’re going to be scrutinizing this kind of thing.”
The article is forwarded from: Jinshi Data