Key takeaways
At its mid-September meeting, the Federal Reserve cut interest rates for the first time in four years.
The Fed’s policymaking Federal Open Market Committee cut rates by 0.50%.
This move is expected to inaugurate a series of rate cuts over the next 1-2 years.
The Federal Reserve (Fed) is recalibrating monetary policy. At the September meeting of the Federal Open Market Committee (FOMC), the panel implemented a 0.50% rate cut in the federal funds target rate, representing the first interest rate change in a year and the first rate cut in more than four years. The half-point drop in the fed funds rate, the rate banks charge each other for overnight lending, to a range of 4.75% to 5.00%, is an aggressive start to the rate-cutting process.
The Fed held the line on rates at a 5.25% to 5.50% range since July 2023. Between March 2022 and July 2023, the Fed raised rates eleven times, from near 0%. The 0.5% cut in September is expected to inaugurate a series of rate cuts over the next 1-2 years.
The Fed’s primary purpose in raising rates and keeping them elevated was to combat the most significant inflation threat since the early 1980s. At its peak, inflation, as measured by the Consumer Price Index (CPI), reached 9.1% for the 12 months ending in June 2022. The most recent CPI reading, for the 12 months ending in August 2024, showed inflation at a much-improved 2.5%.1
Recent favorable trends appeared to convince most FOMC members that inflation may be under control. “Our patient approach over the past year paid dividends,” said Fed Chair Jerome Powell following the September FOMC meeting. “Inflation is now much closer to our objective, and we have gained greater confidence that inflation is moving sustainably toward 2%,” which represents the Fed’s target rate.2
As the Fed became gained confidence about inflation’s direction, it appeared increasingly focused on the U.S. labor market. Slowing payroll growth and a rising unemployment rate are concerns.1 “The Fed doesn’t want to see too much softness in the employment market,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. That would contribute to a slowing economy. “It appears the Fed is putting more attention on jobs data and a little less on inflation reports.”
“The Fed doesn’t want to see too much softness in the employment market,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “It appears the Fed is putting more attention on jobs data and a little less on inflation reports.”
Haworth notes initial jobless claims provide a helpful “real-time” guide on the state of the jobs market. “Initial claims continue to hold within a modest range, which shows that the labor market remains stable for now,” says Haworth. Initial jobless claims in mid-September 2024 dropped to their lowest level since May, showing continued labor market steadiness.3
While there was uncertainty prior to the FOMC’s September meeting as to how much the Fed would initially cut rates, bond markets appeared to be pricing in the 0.50% rate cut that eventually occurred. “In recent months, bond yields have fallen far and fast,” says Haworth. “In April, the 2-year Treasury bill was at 5%. Now it is down to 3.6%.” Similarly, the 1-month Treasury bill, the closest comparison to the fed funds rate, fell from 5.55% on August 8, 2024, to 5.05% on the day prior to the Fed’s rate cut announcement, and then on the day of the Fed’s announcement, it fell below 5%.4
Strong 2024 equity market performance, particularly recent gains in sectors with interest rate sensitivity, such as real estate and utilities, also reflected the market’s expectation of pending rate cuts.
At the September FOMC meeting, members laid out their projections for future fed funds rate cuts. Currently, they project another 0.50% of cuts in 2024 and 1.00% of additional cuts over the course of 2025. That could happen with 0.25% cuts at the November and December FOMC meetings and cuts at every other meeting in 2025.
The CME FedWatch Tool, which analyzes the probabilities of fed fund rate changes based on interest rate trader actions, indicates a high likelihood of a 0.25% rate cut at the FOMC’s November meeting. A smaller number of traders project a November rate cut of 0.50%.5
Powell provided some perspective on the FOMC’s position after September’s meeting. “There’s nothing in the SEP (Summary of Economic Projections, which reflect forecasts of FOMC members) that suggests the committee is in a rush to get this done,” said Powell. “This process evolves over time.”2 Powell emphasized the Fed remains highly data dependent and will determine the pace of cuts meeting by meeting.
The other factor investors are eyeing, according to Haworth, is where the Fed would ultimately like to take interest rates. “The question is the level which would be considered a ‘neutral’ fed funds rate. Markets are likely to watch that closely.”
The fed funds rate was maintained at near 0% from the onset of the COVID-19 pandemic in early 2020 until March 2022. Powell said “My own sense is we’re not going back to that,” though he would not signal a specific interest rate that would be considered by the Fed to be “neutral.”2 The FOMC indicated in the Summary of Economic Projections that the rate would settle near 3%.6
Dating back to the financial crisis of 2008, the Fed has routinely purchased bonds to bolster market liquidity. However, starting in March 2022, the Fed began reducing its bond holdings. In June, the Fed adjusted its policy, slowing the reduction in its Treasury holdings from $60 billion per month to $25 billion per month. The Fed continues to trim its holdings of mortgage-backed securities by $35 billion per month. Prior to the financial crisis of 2007-08, the Fed’s balance sheet consisted mainly of Treasuries. “It appears the Fed is more focused on trying to work off its book of mortgage-backed securities,” says Haworth. The Fed’s balance sheet of asset holdings grew to just under $9 trillion in early 2022. It’s now been reduced to $7.11 trillion.7 “It seems unlikely the Fed will drop its balance sheet back to the $4 trillion level, as it stood in 2015-16, but given the extent the economy has grown since then, a larger Fed balance sheet may be justified,” says Haworth.
Despite significant Fed monetary tightening, the U.S. economy remains resilient, and it appears that the Fed expects growth to continue. First quarter 2024 annualized Gross Domestic Product (GDP) growth came in slightly lower than expectations, at 1.4%, but second-quarter GDP more than doubled that pace, expanding at an annualized rate of 3%.8 “The consumer is still hanging in there,” says Eric Freedman, chief investment officer for U.S. Bank Wealth Management. “However, the environment may be getting a little tougher for lower-income consumers.” Notably, FOMC members, in their most recent estimate, anticipate that for all of 2024, GDP will expand 2%, a slight drop from 2023’s 2.5% GDP growth rate and a modest downward adjustment from the FOMC’s previous projections.6
After September’s Fed meeting, Powell expressed confidence about the economy’s direction. “I don’t see anything in the economy right now that suggests the likelihood of a downturn is elevated,” stated Powell. “You see a labor market that’s still at very solid levels.”2
Be sure to consult with your financial professional and review portfolio positioning to determine if changes might be appropriate given your goals, time horizon and feelings toward risk in today’s evolving interest rate environment.
Monetary policy is controlled by a nation’s central bank, which in the United States, is the Federal Reserve (Fed). The Fed’s management of monetary policy can have a significant impact on the shape of the nation’s economy. Congress’ mandate for the Fed is to maintain price stability (manage inflation); promote maximum sustainable employment (low unemployment); and provide for moderate, long-term interest rates. Fed monetary policy influences the cost of many forms of consumer debt such as mortgages, credit cards and automobile loans.
The Fed is the nation’s central bank, and perhaps the most influential financial institution in the world. The central governing board of the Federal Reserve reports to Congress, with the chair of the Federal Reserve appointed by the President. There are also 12 regional federal reserve banks that are set up like private corporations.
The Federal Reserve’s Federal Open Market Committee (FOMC) sets a target interest rate policy for the federal funds rate. This is the rate at which commercial banks borrow and lend excess reserves to other banks on an overnight basis. The fed funds rate is raised or lowered usually to help impact underlying economic conditions. For example, in 2022, as inflation surged, the FOMC began raising interest rates to make borrowing more expensive and slow economic activity. That strategy was designed to ease pricing pressures and reduce the inflation rate. In periods when the economy is slow or in a recession, the Fed tends to lower rates to try to stimulate economic activity and help the economy expand again.
As interest rates change, learn what the ripple effects across capital markets may mean for investors.
With the Federal Reserve poised to cut interest rates, what opportunities does this create for bond investors?
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