The Federal Reserve agreed to cut its interest rate for the second straight time on Thursday, moving at a less aggressive pace than before but continuing its efforts to improve monetary policy.
In a follow-up to the large half-percentage-point cut in September, the Federal Open Market Committee cut its benchmark overnight borrowing rate by a quarter-point, or 25 basis points, to a target range of 4.50%-4.75%. The rate sets what banks charge each other for overnight lending, but it often affects consumer debt instruments such as mortgages, credit cards and car loans.
Markets had widely anticipated the move, which was announced at the September meeting and in subsequent statements from policymakers since then. The vote was unanimous, unlike the previous move that saw the first “no” vote from a Fed governor since 2005. This time, Governor Michelle Bowman agreed with the decision.
The post-meeting statement reflects some adjustments in how the Fed views the economy. Among them was a changing view on how to evaluate efforts to reduce inflation while supporting the labor market.
“The Committee considers that the risks to achieving its employment and inflation targets are approximately balanced,” the document said, a change from September when it indicated “greater confidence” in the process.
Recalibrate policy
Fed officials have justified the easing approach to policy because they believe that supporting employment has become at least as important a priority as stopping inflation.
The statement downgraded the labor market slightly, saying, “Conditions have generally improved, and the unemployment rate has risen but remains low.” The committee again said that the economy “continued to expand at a strong pace.”
Officials have largely framed the policy change as an attempt to bring the interest rate structure back in line with the economy as inflation drifts back to the central bank's 2% target while the labor market has shown some signs of slowing. Fed Chairman Jerome Powell has talked about “recalibrating” policy to where it no longer needs to be as restrictive as it was when the central bank focused almost entirely on taming inflation.
There is uncertainty about how far the Fed will need to cut as the overall economy continues to see strong growth and inflation remains a stifling issue for US households.
GDP grew at a rate of 2.8% in the third quarter, lower than expected and slightly below the second quarter level, but still above the US historical trend of 1.8% to 2%. Preliminary tracking for the fourth quarter indicates growth of about 2.4%, according to the Federal Reserve Bank of Atlanta.
Overall, the labor market has held up well. However, nonfarm payrolls rose by just 12,000 in October, although the weakness was partly attributable to storms in the Southeast and labor strikes.
The decision comes amid a changing political backdrop.
President-elect Donald Trump won a stunning victory in Tuesday's election. Economists largely expect his policies to pose challenges to inflation, with his stated intentions of punitive tariffs and mass deportations of illegal immigrants. However, in his first term, inflation remained low while economic growth remained strong, outside of the initial phase of the Covid pandemic.
However, Trump has been a fierce critic of Powell and his colleagues during his first term in office, and the president's term ends in early 2026. Central bankers studiously avoid commenting on political matters, but Trump's dynamism could be a drag down the road. For future policy.
The acceleration of economic activity under Trump could convince the Fed to cut interest rates less, depending on how inflation reacts.
During a press conference on Thursday, Powell said that the new administration would not directly consider monetary policy.
“In the near term, the elections will have no impact on our policy decisions,” Powell said. The November meeting was postponed by a day due to the election.
Powell also said he would not step down even if the president-elect asked for his resignation.
The pace of future cuts
Questions have been raised about what the Fed's “ultimate” point will be, or the point at which it will decide it has cut enough and its benchmark interest rate will be where it neither pushes nor holds back growth. Traders expect the Fed will likely approve another quarter-point cut in December and then pause in January as it assesses the impact of its tightening moves, according to CME Group's FedWatch tool.
“We broadly interpret the statement as indicating a flat policy trajectory for now as policymakers take their time to absorb emerging Trump shocks to economic policy, financial conditions and animal spirit, with another downgrade in December a good base case,” said Krishna Guha, Vice President of Evercore ISI.
The Federal Open Market Committee indicated in September that members expect cuts to increase by half a percentage point by the end of this year, then another full percentage point in 2025. A September “dot chart” of individual officials’ expectations indicated a final rate of 2.9. %. Which means further cuts of half a percentage point in 2026.
Even as the Federal Reserve lowered interest rates, markets did not respond in kind. Treasury yields have jumped higher since the September cut, as have mortgage interest rates. For example, the 30-year mortgage rate rose about 0.7 percentage points to 6.8%, according to Freddie Mac. The 10-year Treasury yield rose by about the same amount.
The Fed seeks to achieve a “soft landing” for the economy through which it can reduce inflation without causing a recession. The Fed's preferred inflation index recently showed a 12-month rate of 2.1%, although core inflation, which excludes food and energy and is generally considered a better long-term indicator, was 2.7%.
