WASHINGTON – The Federal Reserve on Wednesday cut interest rates for the first time since the early days of the coronavirus pandemic, slashing its benchmark interest rate by half a percentage point in an effort to stave off a labor market slowdown.
With both employment and inflation softening, the central bank’s Federal Open Market Committee decided to cut its key overnight borrowing rate by half a percentage point (50 basis points), confirming market expectations that had recently shifted from expectations of a cut of half that size.
Excluding the emergency rate cuts during the COVID-19 pandemic, the last time the FOMC cut rates by half a percentage point was during the 2008 global financial crisis.
The decision will lower the federal funds rate to a range of 4.75% to 5%. The rate sets short-term borrowing costs for banks but also trickles down to several consumer products, including mortgages, auto loans and credit cards.
In addition to this cut, the committee suggested through its “dot plot” the equivalent of a 50 basis point cut to market rates by the end of the year. The officials’ projection matrix suggests another one percentage point cut by the end of 2025 and a half-point cut in 2026. Overall, the dot plot suggests the benchmark rate will fall by about two percentage points from Wednesday’s move.
“The Committee is increasingly confident that inflation is moving sustainably toward 2 percent and judges that the risks to achieving its employment and inflation objectives are roughly balanced,” the statement said after the meeting.
The decision to ease was made “taking into account the evolution of inflation and the balance of risks.” Notably, the FOMC voted 11-1, with Michelle Bowman favoring a quarter-point rate hike. Bowman’s dissent was the first by a Fed governor since 2005, although many regional presidents have voted against during that period.
“We are trying to get to a situation where we restore price stability without the painful increases in unemployment that sometimes occur with this inflation. That’s what we’re going to do, and I think today’s action will be seen as a signal of our strong commitment to achieving that goal,” Chairman Jerome Powell said at a news conference after the decision.
Trading was volatile after the decision, with the Dow Jones Industrial Average soaring as much as 375 points after the announcement but then calming somewhat as investors digested the news and considered what it might suggest about the state of the economy.
Stock prices fell slightly on the day, but government bond yields rose.
“This is not the start of a 50 basis point cut. The market thought that if we cut 50 basis points, there was a high probability of another 50 basis point cut. But I [Powell] “That idea has been shot down to some extent,” said Tom Porcelli, chief U.S. economist at PGIM Fixed Income. “It’s not that he thinks it won’t happen, but he’s not pre-committing to it happening, which is the right call.”
“Employment growth has slowed and the unemployment rate has risen, but remains low,” the Committee noted. FOMC officials raised their forecast for the unemployment rate this year to 4.4%, up from 4% in their last update in June, and lowered their inflation outlook to 2.3% from 2.6% previously. For core inflation, the Committee lowered its forecast to 2.6%, down 0.2 percentage points from June.
The Committee expects the longer-run neutral rate to be around 2.9 percent, but that level has been trending higher as the Fed struggles to drive inflation down to 2 percent.
The decision comes despite most economic indicators looking fairly strong.
Gross domestic product has been rising steadily, with the Atlanta Fed projecting 3% growth in the third quarter, based on continued strength in consumer spending. Moreover, the Fed chose to cut rates even though most indicators show inflation running well above the central bank’s 2% target. The Fed’s preferred indicator shows inflation hovering around 2.5%, well below its peak, but still higher than policymakers would prefer.
But Powell and other policymakers have expressed concern about the labor market in recent days. Layoffs show little sign of recovery, while hiring has slowed significantly. In fact, the last time monthly employment was this low, at 3.5% of the labor force, the unemployment rate was above 6%.
At a press conference following the July meeting, Chairman Powell said a 50 basis point rate cut was “not on the table at this time.”
For now, at least, the move will help settle the debate about how much force the Fed should have used in its original actions.
But this raises future questions about how far the central bank should go before stopping its rate cuts. There was wide variation among members on the direction of interest rates over the next few years.
Investor confidence in a rate cut had been wavering in the days leading up to the meeting: Over the past week, the likelihood of a cut had risen to half a percentage point, according to CME Group’s FedWatch index, and just before the decision, the chances of a 50-basis-point cut were at 63%.
The Fed last cut interest rates on March 16, 2020, as part of its emergency response to the economic shutdown caused by the COVID-19 pandemic. It began raising interest rates in March 2022, when inflation hit its highest level in more than 40 years, and its last rate hike was in July 2023. During the tightening policy, the Fed raised interest rates four consecutive times by 75 basis points.
The current unemployment rate is 4.2%, and although it has been trending upwards over the past year, it is still at a level that is considered full employment.
“This is an unusually large cut,” Mr. Polselli said. “We’re not knocking on the door of a recession. This easing and this small cut is just recalibrating policy in light of the fact that inflation has slowed quite a bit.”
Given the Fed’s position at the center of global finance, Wednesday’s decision is likely to have ripple effects among other central banks, some of which have already started cutting interest rates. The factors that have boosted global inflation are mostly related to the pandemic: a breakdown in international supply chains, unusually high demand for goods over services, and an unprecedented influx of monetary and fiscal stimulus.
The Bank of England, the European Central Bank and the Bank of Canada have all recently cut interest rates, but other central banks have waited for guidance from the Fed.
The Fed approved the rate cuts but left intact a program to gradually reduce its bond holdings. This process, known as “quantitative tightening,” has seen the Fed’s balance sheet shrink to $7.2 trillion, down about $1.7 trillion from its peak. The Fed is allowed to reduce maturing Treasury bonds and mortgage-backed securities by up to $50 billion each month, down from $95 billion at the start of quantitative tightening.
