Fed cuts start with a bang

Before Wednesdays meeting, the US Federal Reserve found itself in a slightly awkward spot. Generally, these days Central Banks like to see financial markets reflect the decision they’re about to make (it wasn’t always that way). On this occasion, however, market expectations were fairly divided, unclear if the Fed would lower rates by 25 or 50 bps. 

As it turned out, the Federal Reserve lowered its policy rate by 50 bps, its first cut since COVID. 50 bps is a fairly aggressive move, usually only deployed during a crisis, at least in recent years. So, Fed Chair Powell had to make the case for why the move was warranted while reassuring everyone that he doesn’t believe the US economy has a problem. Fortunately for him, many investors were already convinced that 50 bps was warranted, even though the US economy remains in fairly good shape. Powell had already laid the groundwork in his speech at Jackson Hole in August, highlighting the shift in focus from inflation to the slowing labour market, something that is required given the Feds mandate to maintain both price stability and full employment. 

But was a 50 bps cut really warranted? At first glance, you’d argue not. The US economy is still pretty robust, as evidenced by some decent retail sales figures earlier this week. Unemployment is rising, but from low levels. Jobs are still being created and real wages are growing quite nicely. On the other side of the argument, we’ve clearly seen the labour market softening – unemployment is rising after all and jobs aren’t as plentiful as they once were. And that deterioration could clearly pick up steam. 

At the same time, the Fed hasn’t really given up very much by cutting 50 bps now. Fed chair Powell was at pains to stress that 50 bp cuts aren’t “the new pace” for the US Central Bank. Market expectations for where the policy rate will be at the end of the year didn’t move very much in the wake of the announcement. So, it looks like the Fed has managed to send a strong signal that it will support the labour market, while keeping expectations for future rate cuts under control. 

What does it mean for markets? We’d argue that the Feds move is broadly positive. Powell signalled a focus on the labour market without raising particular concerns over the current state of the economy. The relationship between interest rate cuts and equity markets isn’t always clear. What matters more, we think, is whether or not the rate cuts coincide with a recession. The current data suggests that the US isn’t in a recession and that a soft landing, of slowing growth, is the most likely scenario – particularly given the tailwind of interest rate cuts. That should be supportive for risky assets. 

Where could we be wrong? There are at least two areas. First, that the US economy proves to be weaker than we think. The labour market is slowing and maybe that slowdown accelerates. It’s not our base case today, but we’ll continue to keep a close eye on the macro data. The second is around inflation. The message from the US Central Bank is that inflation is not currently their chief concern, even if it’s still a bit higher than they’d like. With domestic demand in the US still fairly healthy, it’s possible that inflation could re-accelerate faster than the Fed and investors expect. Not our base case today, and probably not an issue for the next few quarters, but something to consider. 

All that said, we think the start of an easing cycle combined with a still-growing US economy is a positive combination and, if it sustains, would be a far better outcome than many had predicted eighteen months ago.