US Federal Reserve: Fast out of the blocks... or a false start?

The economist view – Melanie Baker, Senior Economist

In contrast to most economist expectations, but in line with what the market had been increasingly pricing, the Federal Reserve cut 50 basis points to 4¾%-5% last night.

Their forecasts indicate that they anticipate that as the first of a series of cuts, but the broad messaging could have been more ‘dovish’ and Bowman dissented, preferring a 25bps cut rather than a 50bps one.

Not about recession

From the opening paragraph of the statement, this was not presented as a cut in response to a sizeable jump in recession concern or to the Fed seeing something worrying that others aren’t. They see diminished upside risks to inflation and increased downside risks to employment and have cut accordingly, but also painted a picture of an economy which was still doing well. From Powell’s opening statement, the cut “reflects our growing confidence that, with an appropriate recalibration of our policy stance, strength in the labour market can be maintained in a context of moderate growth and inflation moving sustainably down to 2 percent.”

He defended the decision to go 50bps (rather than something smaller) largely on the grounds of that representing a commitment to keep the economy strong rather than being in response to economic weakness. He said that the US economy is in a good place and their decision is intended to keep it there. The US economy is “basically fine” if you talk to business people, he said and saw the move as a commitment to make sure they don’t fall behind.

First cut in a process

Powell talked (repeatedly) about the cut as beginning the process of returning rates “to a more neutral stance”

The ’dot plots’ – the individual forecasts of FOMC participants – do suggest that policymakers expect this to be the start of a cutting cycle but not an extremely rapid one and to neutral rather than below it. The median dot plot has another 50bps of cuts for this year (just – there were a large number of participants pencilling in 25bps or less) and then a further 100bps of cuts the following year. They also revised up their longer-run rate forecast (arguably a proxy for where the Fed think the longer-run neutral might be) to 2.9% (from 2.8%) with the median forecast getting to that point in 2026.

The Fed have made a stronger start to their cutting cycle than I’d expected… That points to a more rapid rate cutting cycle than anticipated.

But no preset path

Powell talked about them not being on any preset course. Looking at the guidance language in the statement itself: “In considering additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals.”

Not in a big hurry / don’t get used to 50bps cuts

Powell pointed out that “There is nothing in the SEP [the forecasts of participants] that suggests the Committee are in a rush to get this done.” He also came back a few times to uncertainty around where neutral is (“we will know it by its works”). At one point he said they have made a good strong start to this – a sign of their confidence on inflation – but that, “I think we are going to go carefully meeting by meeting.” Then later: “I do not think that anyone should look at this and say this is the new pace.”

Reviewing the forecast

The Fed have made a stronger start to their cutting cycle than I’d expected, cutting more in response to a perceived change in the balance of risk and less in response to a turn in the data. That points to a more rapid rate cutting cycle than anticipated (though at this stage to a similar point).  It seems likely that they will cut again this year (though possibly only 25bps rather than 50bps given how the data is breaking) and still pencilling in 75bps-100bps in cuts next year makes sense given my central forecast for further inflation progress and somewhat slower growth, but no recession.  

The government bond manager view – Craig Inches, Head of Rates & Cash

The Fed has delivered an oversized first rate cut – the first since the early days of Covid pandemic of 0.50% – taking the Fed funds rate to 4.75% - 5.25%. This was not expected by economists with only a small handful predicting a move of this magnitude. However, the market had hedged its bets, by predicting a 50:50 chance that the Fed may produce a bigger ‘surprise’. The ‘surprise’, when it came, was perhaps slightly muted as in the days preceding the Fed meeting there had been a number of prominent voices suggesting that a 50bps cut was potentially a likely outcome. The initial market reaction saw short-dated bonds rally, however what followed, sparked a bit more confusion and head scratching.

The rate was cut by 0.50% but the language accompanying the move was arguably hawkish.

I am still trying to interpret the messaging and whether we could actually be witnessing an early policy mistake by Powell and the committee. The rate was cut by 0.50% but the language accompanying the move was arguably hawkish. Apparently, we were informed that the rate cut was “from a position of strength, not from a position of weakness” and that the Fed would not continue to cut rates at this pace. But then they revised down their forecast of rates (dots) by 50bps by end of this year and 75bps for 2025 to 4.375% and 3.375% respectively.

It appears to us that the Fed’s thought process was to nail the ‘soft landing’ and it would appear that global equities were emboldened by this news. However, bond markets were less convinced and began to sell off later in the session, led by longer dated bonds, on the assumption that a faster moving Fed may mean that rates don’t need to fall as much as markets have priced in. There is also the risk that if this does turn out to be a policy error then the US economy, which in my opinion, still has robust growth, labour and wages, could see a sharp upturn in consumer confidence and resultant inflation expectations. This would continue to put upward pressure on yields or push curves steeper. Only time will tell, but it is likely we will see more market fireworks before November!

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