Five keys to understand the Fed’s aggressive interest rate cut

The U.S. Federal Reserve on Wednesday began a cycle of interest rate cuts after reining in inflation, which is nearing the 2% price stability target. Fed Chair Jerome Powell believes the risks are now balanced for the achievement of his dual mandate: maximum employment and stable prices. As monetary policy is now tight, it is time to ease it. Wednesday’s half-percentage-point cut to the key benchmark rate met most investors’ expectations. Democratic presidential candidate Kamala Harris applauded the move, while her Republican rival Donald Trump tried to present it as a sign that the economy is not doing well. Powell argues the opposite: he believes he is on time to avoid a recession and that the economy is doing well. It is a matter of not ruining an almost ideal scenario.

1. The market got it right, at the last minute

Powell had made it as clear as a central banker can that there would be rate cuts. “The time has come,” he said in recent weeks. He also noted that the Fed had “ample room” to respond to the weakening labor market. Still, most economists saw a 25 basis point cut as more orthodox and prudent to begin with, as the labor market continues to create jobs and inflation has not yet reached the 2% price stability target.

At the end of last week, the market began to count on a rate cut of 50 basis points. And this week, investors were moving in that direction. Still, the stakes were high, with an implied probability split in the order of 60%-40% in favor of the more aggressive option. The market got it right, but only at the last minute and without much conviction.

The question now is how the cut will affect investors. The initial stock market response was bullish, but then the market turned around and ended up closing slightly lower. Recent historical data, reviewed by Goldman Sachs, shows that the S&P 500 rises between 10% and 17% after the first rate cut if there is no recession, but falls by 15-20% if there is.

2. Powell doesn’t see anything even resembling a recession

The Fed chief does not buy into the message that the country is on the brink of a recession. “The U.S. economy is in a good place, and our decision today is designed to keep it there,” he said. At the news conference following the meeting, some reporters insisted on asking about the risks and threats looming ahead, but Powell stuck to his message of optimism.

The Fed chair does not agree that central bankers are acting too late. He believes they are on time and in a good position to react to any unforeseen events, as he noted in defending the half-point rate cut. “This decision reflects our growing confidence that, with an appropriate rebalancing of our economic policy, the strength of the labor market can be maintained against a backdrop of moderate growth and inflation declining sustainably to 2%,” he said.

3. A soft landing scenario

The new projection by Fed members paints an almost idyllic scenario of a soft landing for the economy, with solid growth, inflation close to target and an unemployment rate that rises only slightly. Again, there is no sign that Fed members see a recession on the horizon.

The new projections suggest that the year will end with an unemployment rate of 4.4%, two tenths of a percentage point above the current level. By the end of 2025 it would fall to 4.3% by 2026 and to 4.2% in 2027. Meanwhile, the PCE index, the Fed’s preferred inflation indicator, would close the year at 2.3% (always according to the median projection, the one with as many projections above as below). In 2025, it would drop to 2.1%, before reaching the 2.0% target in 2026.

4. The first in a series

The central bankers are a bit more restrained than the market in their bets on further cuts in the price of money, but the median projection is for rates to end the year at 4.25%-4.5%, half a point below the current level. The most natural way to achieve this would be with two 0.25-point cuts at each of the next two FOMC meetings, on November 7 and December 18.

But Powell insisted that nothing has been decided yet. “We’re going to take it meeting by meeting. We made a good, strong start to this, and that is frankly a sign of our confidence, confidence that inflation is coming down.”

5. Political implications

For months it had been clear that Powell was preparing to lower rates in an election year. Not for political reasons, but because the turning point from fighting inflation to avoiding recession was at hand. The Republican candidate, Donald Trump, made it clear that he did not like the idea. Not because it was not good for the United States, but precisely because it could be good for the economy and thus benefit the Democrats in government.

The former president, who has a grudge against Powell for defending his independence, did not like the fact that the Fed has lowered rates at the last meeting before the November election. Or that it did so with a message of economic optimism that any member of the Kamala Harris campaign would subscribe to. Trump has tried to ignore that positive message. “It was a big cut,” he said Wednesday, then implied that the cut was an indication of how bad the economy was doing, even though that’s not what the data say or what the Fed chairman maintains.

Sign up for our weekly newsletter to get more English-language news coverage from EL PAÍS USA Edition