In a move that was widely anticipated, the Federal Reserve lowered its main interest rate on Wednesday by a quarter of a percentage point, marking the third successive reduction.
This latest easing was accompanied by a cautionary note, indicating a more measured approach for future rate cuts.
Markets expected this decision, but it reflects the Fed’s delicate balancing act as it navigates persistent economic growth and persistent inflation.
Navigating an economic landscape that is complex
The Federal Open Market Committee has reduced the overnight lending rate to a range of 4.25%-4.5%. This was a level that was last seen in December 20,22, before rates began to rise.
The market had already priced in the Fed’s decision to cut rates, but the focus was on its forward guidance.
In general, policy easing does not coincide with a solid economic growth or inflation that remains above target.
The Fed’s nuanced strategy suggests that it should recalibrate its strategy.
The “dot plot matrix”, which reflects the future expectations of individual members, indicates that there is a good chance that the Fed will only lower rates twice more in 2025.
This projection is a significant decrease from the September forecast of the committee, which had predicted doubling the rate cuts during that period.
The Fed expects to cut the funds rate by another two quarter points in 2026, and then one more in 2027 before reaching the long-term “neutral fund rate” of 3%. This figure has increased since its September update, due to the gradual upward trend this year.
Market reactions and dissenting voices
There was internal conflict at the FOMC for the second time in a row.
Beth Hammack, the Cleveland Fed president, dissented and argued for rates to stay unchanged.
This follows Governor Michelle Bowman voting against a rate-decision in November. It was the first time since 2005 that a governor dissented.
The Fed funds rate is a key instrument in monetary policy. It influences consumer debt, such as auto loans and credit cards.
The language used to describe the “amount and timing” of rate changes in the future was slightly different from the previous meeting held in November.
The committee upgraded its projections for the full-year growth of gross domestic product to 2.5%. This is a half-point increase from September.
Officials expect the GDP to slow down to its long-term forecast of 1.8% in the long term.
The Summary of Economic Projections showed that the unemployment rate for this year had been revised downwards to 4.2%. However, the Fed’s preferred inflation gauge, which measures the core and headline rates, was revised upwards, to 2.4% and 2.8% respectively. These figures are slightly higher than September’s estimates and above the Fed’s 2% target.
Economic growth versus inflation
The Atlanta Fed reports that the Fed’s decision is made at a time of high inflation and a projected growth rate of 3.2% in the fourth quarter, with an unemployment rate of around 4%.
Officials are reluctant to maintain rates that could lead to an unwarranted economic slowdown, even though these conditions are more in line with either maintaining or increasing rates.
A recent Fed report indicated that the economic growth was only “slightly up” in recent weeks. There were also signs of waning unemployment and a slowdown in hiring.
Fed Chair Jerome Powell indicated that the rate cuts were part of the central banks efforts to recalibrate its policy, as it doesn’t need to be restrictive in the current conditions.
Market skepticism
With the Fed’s decision on Wednesday, it will have lowered benchmark interest rates by a whole percentage point since September.
In September, they took the unusual step to cut rates by half a point.
The Fed prefers to adjust the rate in quarter-point increments, as they carefully evaluate the impact of such adjustments.
The markets are showing signs that they are sceptical despite these significant drops. Mortgage rates and Treasury yields have both risen sharply in the same time period, possibly signaling an absence of confidence that the Fed will continue to cut rates.
The most recent yield on the policy-sensitive 2-year Treasury was 4.215%. This is within the upper range of Wednesday’s rate change by the Fed.
This post US Fed cuts rates by 0.25%; projects fewer reductions by 2025 may be updated as new developments unfold.
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