Introduction to Interest Rate Cuts
The Federal Reserve has made the decision to cut interest rates by 0.25 percentage points. This move is part of a series of cuts that began in September 2024, following a pause after the December 2024 meeting. The federal-funds rate now falls within a target range of 3.75%-4.00%. Since September 2024, the Fed has cut rates by a total of 1.5 percentage points.
Current Economic Conditions
Prior to the current cuts, the rate had been at a high of 5.25%-5.50% from July 2023 to September 2024. Although the rate has decreased, it remains significantly above the pre-pandemic average of 1.7% from 2017 to 2019. The 10-year Treasury yield increased to 4.07% from 3.98%, and the 2-year yield rose to 3.59% from 3.49% on the day of the announcement.
Fed’s Concerns and Actions
The Fed is less concerned about inflation but remains cautious about the job market. The latest Consumer Price Index data showed a slight increase in inflation in September, partly due to tariffs. However, this increase is not alarming, and it’s plausible that inflation will decrease in the next year. The core PCE, the Fed’s preferred measure of inflation, is likely to be around 2.8% year over year, which is not significantly above the Fed’s 2% target.
Jobs and Economic Growth
The job market has shown deteriorating conditions, with slowing employment growth. However, GDP growth remains robust, creating a conflict in the data. This discrepancy is unlikely to persist, and either job growth will re-accelerate, or the labor market will negatively impact GDP. The Fed has chosen to cut rates due to the potential downside risk to full employment and the modestly above-target inflation.
December Rate Cut Uncertainty
The decision for the current rate cut was not unanimous, with 10 out of 12 FOMC members voting in favor. The path forward is uncertain, with the two parts of the Fed’s mandate pulling in opposite directions. Inflation is above target, suggesting more restrictive monetary policy, while the risk to full employment calls for the opposite. The market had priced in another cut with high probability, but the decision for a December rate cut is uncertain, with the probability shifting down to around two-thirds after the Fed’s remarks.
Conclusion
In conclusion, the Federal Reserve’s decision to cut interest rates is a response to the current economic conditions, including the potential risks to full employment and the modestly above-target inflation. The path forward is uncertain, with conflicting data and differing opinions among FOMC members. The cessation of quantitative tightening as of December 1 is also a notable decision, although its impact is expected to be minimal. As the economic situation continues to evolve, the Fed will need to carefully weigh the risks and make decisions to support the economy while maintaining its dual mandate.
