Fed Went Big
The Fed took a decisive step to defend the US economy, slashing its benchmark interest rate by half a percentage point. This bold move, aimed at bolstering the labour market, marks an aggressive start to a policy shift after the Fed had held rates at their highest level in two decades for over a year.
In a vote of 11 to 1, the FOMC lowered the federal funds rate to a range of 4.75% to 5%. Governor Bowman cast the sole dissenting vote, favouring a smaller rate cut. The committee's projections revealed that a narrow majority—10 out of 19 officials—anticipate at least another half-point cut over the remaining two meetings in 2024. A further 100bps is forecast for 2025 and 50bps in 2026.
The Fed emphasised its strong commitment to supporting maximum employment and achieving 2% inflation, judging that the risks to these goals are now roughly in balance. Despite the rate cut, Fed policymakers have boosted their expectations for unemployment. The median forecast now stands at 4.4% for year-end, up from the current 4.2% and higher than the 4% rate projected in June. This forecast remains unchanged for next year, suggesting the Fed assumes a relatively resilient job market without a significant spike in joblessness.
Fed Chair Powell explained the jumbo cut, stating, "This 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%." However, Powell cautioned against assuming this 50bp move sets a precedent for future cuts.
The Fed's decision has sparked significant reactions in debt markets. Two-year Treasury yields tumbled almost 10bps from pre-decision levels, reflecting the market's dovish interpretation of the Fed's actions. Corporate bonds rallied, with the rate cut fuelling demand for scarce supply of corporate debt. This has led to further distortion of risk premia at the riskiest end of the market. Credit default swap (CDS) indexes hit two-month highs following the decision, with potential for further increases. Furthermore, stocks with smaller market capitalisations spiked after the announcement, indicating that traders expect this 50bps cut will stimulate the broader economy and stock market beyond just the mega-cap technology names that have driven most of this year's gains.
Investors have adopted their most risk-on positioning since rate hikes began in 2022. The lower rates are reducing the appeal of short-term money-market funds, prompting a shift of cash into duration and risk products such as credit. This movement is incentivised by ever-lower yields, encouraging investors to act swiftly.
In addition to the headline rate cut, the FOMC made other key adjustments. The Interest on Reserve Balances (IOR) was lowered to 4.9%, and the discount rate was reduced to 5%. Interestingly, the FOMC's median longer-run federal funds rate projection increased slightly to 2.9% from 2.8%.
As markets digest this significant policy shift, investors are closely monitoring how this "recalibration" will impact various sectors of the economy. The Fed's decisive action underscores its commitment to maintaining labour market strength while pursuing sustainable inflation targets. The coming months will reveal the full extent of this rate cut's influence on the US economy and global financial markets, particularly in light of the Fed's updated projections and risk assessments.
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