WASHINGTON – The U.S. Federal Reserve on Wednesday approved its first interest rate cut since the early days of the COVID-19 pandemic, slashing a half percentage point from its benchmark interest rate in an effort to stave off a slowdown in the labor market.
With the jobs and inflation picture deteriorating, the central bank's Federal Open Market Committee opted to cut its key overnight lending rate by half a percentage point, or 50 basis points, confirming market expectations that had recently shifted from expectations of a cut of half that size.
Excluding emergency rate cuts during the COVID-19 period, the last time the FOMC cut interest rates by a half point was in 2008 during the global financial crisis.
The decision lowers the federal funds rate to a range of 4.75% to 5%. While that rate sets short-term borrowing costs for banks, it extends to many consumer products such as mortgages, auto loans and credit cards.
In addition to that cut, the committee’s “dot plot” indicated an additional 50 basis points of cuts by year-end, which is close to the market rate. The matrix of individual officials’ projections indicated another full percentage point of cuts by the end of 2025 and a half point in 2026. Overall, the dot plot shows the benchmark rate about 2 percentage points lower than Wednesday’s move.
“The Committee has gained greater confidence that inflation is moving sustainably toward 2 percent, and judges that the risks to achieving its employment and inflation goals are roughly balanced,” the statement issued after the meeting said.
The decision to ease monetary policy was made “in light of progress in addressing inflation and the balance of risks.” The FOMC voted 11-1, with Michelle Bowman, the Fed’s governor, favoring a quarter-point move. Bowman’s dissent was the first by a Fed governor since 2005, although a number of regional bankers have voted “no” during that period.
“We are trying to get to a situation where we restore price stability without the painful increase in unemployment that has sometimes come with this inflation,” Fed Chairman Jerome Powell said at a news conference following the decision. “That’s what we are trying to do, and I think you can take today’s action as a signal of our strong commitment to that goal.”
Trading was volatile after the decision, with the Dow Jones Industrial Average jumping as much as 375 points after the decision was made, before calming down somewhat as investors digested the news and considered what it might suggest about the state of the economy.
Stocks ended trading slightly lower today while Treasury yields rose.
“This is not the beginning of a series of 50 basis point cuts. The market was thinking, if you go to 50, another 50 is a good possibility. But I think (Powell) has kind of screwed that up,” said Tom Porcelli, chief U.S. economist at PGIM Fixed Income. “It’s not that he thinks it won’t happen, it’s that he didn’t commit in advance that it would happen. This is the right decision.”
The committee noted that “job gains have slowed and the unemployment rate has risen but remains low.” Committee officials raised their forecast for the unemployment rate this year to 4.4%, from 4% in their last update in June, and lowered their inflation forecast to 2.3% from 2.6% previously. As for core inflation, the committee lowered its forecast to 2.6%, down 0.2 percentage points from June.
The committee expects the neutral interest rate in the long run to be about 2.9%, a level that has risen higher as the Fed struggles to bring inflation down to 2%.
The decision comes despite most economic indicators looking fairly strong.
GDP has been steadily rising, and the Atlanta Fed expects 3% growth in the third quarter based on continued strength in consumer spending. Moreover, the Fed has chosen to cut interest rates even though most measures suggest inflation is running well above the central bank’s 2% target. The Fed’s preferred measure shows inflation hovering around 2.5%, well below its peak but still higher than policymakers would like.
But Powell and other policymakers have expressed concern in recent days about the labor market. While layoffs show no sign of recovering, hiring has slowed dramatically. In fact, the last time monthly employment was this low — 3.5% as a share of the labor force — the unemployment rate was above 6%.
In his press conference following the July meeting, Powell indicated that a 50 basis point rate cut was “not something we’re considering right now.”
For now at least, the move helps settle a contentious debate about how aggressive the Fed should have been in its initial move.
But that sets the stage for future questions about how far the central bank should go before it stops cutting interest rates. There was wide variation among members on where they expected interest rates to go in the coming years.
Investor sentiment on the move has been mixed in the days leading up to the meeting. Over the past week, the odds of a half-point rate cut have shifted to a 63% chance of a 50 basis point cut just before the decision, according to the CME Group’s FedWatch gauge.
The last rate cut was on March 16, 2020, as part of an emergency response to the economic shutdown caused by the spread of COVID-19. It began raising rates in March 2022 as inflation rose to its highest level in more than 40 years, and last raised rates in July 2023. During the tightening campaign, the Fed raised rates by 75 basis points four times in a row.
The current unemployment rate is 4.2%, up from last year, although it is still at a level that could be considered full employment.
“This was an unusually large cut,” Porcelli said. “We are not knocking on the door of recession. This easing and this slight cut are about recalibrating policy in light of the fact that inflation has slowed quite a bit.”
With the Fed at the center of the global financial universe, Wednesday’s decision is likely to reverberate among other central banks, many of which have already begun cutting interest rates. The factors driving global inflation higher have been primarily pandemic-related — disrupted international supply chains, excessive demand for goods over services, and an unprecedented outpouring of monetary and fiscal stimulus.
The Bank of England, the European Central Bank and the Bank of Canada have all recently cut interest rates, although others have waited for the Fed's signal.
While the Fed has agreed to cut interest rates, it has maintained a program in which it is slowly reducing its bond holdings. This process, called “quantitative tightening,” has reduced the Fed’s balance sheet to $7.2 trillion, down about $1.7 trillion from its peak. The Fed is allowed to withdraw up to $50 billion a month from outstanding Treasuries and mortgage-backed securities each month, down from $95 billion when quantitative tightening began.
