A rate cut that makes you go hmmmm

The Fed kicked off its easing cycle with an assertive 50 basis-point rate cut at yesterday’s meeting, lowering the fed funds target range from 5.25-5.5% to 4.75–5%. The question is why?

Chair Jerome Powell couched the move as recalibration because the risks to the economy have shifted. But a half-percentage-point hike is not fine-tuning. He then said policy was not on any preset course and would be dependent upon upcoming data. If the Fed had started incrementally with a quarter-point step, this gentler, “let’s see what happens,” data-dependent message would have fit. But they started with a move that would be considered “shock and awe" by the traditional Fed playbook. Powell, however, didn’t employ rhetoric to back it up. In fact, he provided little guidance about future easing actions.

By their own forecast, participants cast the economy as being in a Goldilocks zone. Their new Summary of Economic Projections (SEP) indicates they expect GDP growth of 2% over the next four years, the unemployment rate to rise only slightly to 4.4% before starting to edge down in 2025, and core PCE inflation to hit the magical 2% goal by 2026. Not exactly cause for alarm.

This might be why Michelle Bowman, the most hawkish of the current FOMC voters, became the first Fed governor since 2005 to disagree with a decision, preferring a 25 basis-point ease. Dissents are not uncommon during periods of monetary policy transition, but they are most often issued by a regional Fed bank president.

It’s hard not to conclude that the Fed’s oversized cut was made to avoid looking behind the curve. When asked about it, Powell was defensive, saying they don’t think they are behind and the markets should take it as a sign of a commitment to not be behind. Seems like semantics—especially as participants forecast only a total of 50 basis points in rate cuts by year-end. This isn’t an insignificant amount of easing, but not of the magnitude that one would expect given the deep kickoff. Maybe this was, as some have suggested, a catch-up from not starting the easing cycle in July. In addition to median forecast of only an additional 100 basis points of cuts by the conclusion of 2025, taking the median to 3.4%, the SEP reflected only modest easing to 2.9% in 2026, and remaining there in 2027. The longer-run dot, the Fed’s median estimate of a neutral monetary-policy rate, ticked up once again, from 2.8% in the June SEP to 2.9%. This measure stood at 2.5% as recently as the end of last year, and has climbed higher for the last three updates.  

The hawkish cut—words no one ever uttered until yesterday—may help some aspects of the economy, such as housing, but hurt savers and investors. Nonetheless, rates remain at a historically high level, and we think money market yields will exceed 4% for some time.