The Federal Reserve is poised to make a historic decision on interest rates at its policy meeting this week. For the first time in four years, the Fed is expected to rate cuts, marking the end of an aggressive inflation-fighting campaign and signaling the beginning of a new era of monetary easing.
A Pivotal Fed Meeting
This week’s meeting is widely considered a turning point. As former Kansas City Fed president Esther George noted, “This is a big meeting. It’s one that’s been foreshadowed since late last year.
It’s long been expected.” The central bank is predicted to lower the benchmark interest rate by 25 basis points, bringing it down to a range of 5.0% to 5.25% from its current level of 5.25% to 5.5%.
However, there is significant speculation that the Fed may opt for a larger 50-basis point cut as market bets have fluctuated ahead of the decision.
This shift marks the conclusion of one of the most aggressive inflation-controlling policies since the 1980s.
Now, investors are eyeing a future of potentially more rate cuts that could stretch into 2025 and 2026, setting the stage for cheaper borrowing across the economy.
Market Expectations on Rate Cuts
Market expectations leading up to the decision have been volatile. As of early Wednesday, there was roughly a 60% chance of a 50-basis point rate cut, compared to 40% for the expected 25-basis point reduction.
This compares to a more even split just days earlier and a stronger consensus for a smaller cut the week before.
Regardless of the exact size of the cut, this decision will be the first of several moves expected in the coming months as the Fed embarks on its rate-lowering journey.
The timing of this move is noteworthy, as it comes just weeks before the presidential election. Former President Donald Trump and other Republicans have voiced concerns that the Fed should avoid lowering rates until after the election, adding a political layer to the already complex economic decisions.
The Long-Term Outlook for Rates
The anticipated rate cut on Wednesday is not expected to be a one-off event. The Fed is likely to continue reducing rates through 2025, according to many analysts, setting up a new era of easy money.
This will provide significant relief for American consumers and businesses, as borrowing costs for everything from mortgages to auto loans will decrease.
Luke Tilley, the chief economist for Wilmington Trust, forecasts that the Fed will cut rates by 25 basis points in September, with two additional cuts in 2024.
He expects the Fed to ease rates at six out of the eight scheduled meetings in 2025. If conditions allow, the Fed may even pursue larger 50-basis point cuts at future meetings to stay ahead of market expectations.
According to Tilley, the Fed may have delayed the start of its rate cuts, which could explain the market’s heightened anticipation for larger reductions.
However, he believes the exact size of the cuts matters less than the overall trajectory and how the Fed communicates its policy intentions to the market.
The Fed’s Communication Challenge
One of the key challenges for the Federal Reserve will be how it frames its decisions to the public and markets.
Esther George suggests that the Fed needs to craft a coherent narrative around the potential for larger rate cuts.
She expects the central bank to make consistent 25-basis point reductions for the remainder of the year but does not rule out the possibility of more aggressive cuts in the future.
Fed Governor Chris Waller has stated that he is open to larger rate cuts if the economic data justifies them.
Waller was a proponent of front-loading rate hikes during the inflation surge in 2022 and believes that front-loading rate cuts could be equally effective.
Why Is the Fed Cutting Rates Now?
The Fed’s decision to lower rates stems from its increasing confidence that inflation is steadily declining toward its 2% target.
The latest Consumer Price Index (CPI) report showed that inflation has been falling for five consecutive months.
Core inflation, which excludes volatile food and energy prices, has also been moderating, with annual increases of 3.2% in August and July, compared to 3.6% in April.
Inflation expectations are also softening, with the difference between inflation-protected government bonds and standard bonds at its lowest point since 2021.
Over the next two years, markets are predicting CPI inflation of just 1.5%, well below the Fed’s 2% target.
The Cooling Job Market
While inflation is moving in the right direction, the labor market has shown signs of weakening. Job growth has slowed in recent months, with only 118,000 jobs created in June, 89,000 in July, and 142,000 in August.
These figures are well below the average monthly gains of over 200,000 during the previous 12 months.
Fed Chair Jay Powell addressed the labor market in a recent speech, stating that the central bank will do everything it can to maintain a strong labor market while achieving price stability.
Powell also emphasized that the Fed does not want further cooling in employment conditions but believes the current interest rate level provides ample room to respond if the job market weakens further.
Economic Projections and Future Policy
After the meeting, the Fed will release updated economic projections, including forecasts for unemployment, inflation, and growth.
These forecasts will be crucial for understanding how the Fed sees the economy evolving over the next year.
There is also speculation that Powell could set the stage for larger rate cuts at upcoming meetings.
Former Kansas City Fed president George believes that Powell may hint at more aggressive cuts if economic data points to further labor market weakness or slowing growth.
Potential Risks and Concerns
Although the Fed is signaling confidence in a “soft landing” — where inflation falls without triggering a severe recession — there are still risks to the economic outlook. Luke Tilley from Wilmington Trust warns that the economy is slowing and remains vulnerable to external shocks.
These could include an oil price spike that hurts consumer spending or a sudden stock market downturn that forces businesses to scale back hiring.
There is also the potential for policy changes following the presidential election, as candidates like Donald Trump and Kamala Harris have proposed measures, such as new tariffs and tax hikes, that could impact the economy next year.
Conclusion: Navigating a New Economic Era
As the Federal Reserve embarks on this new chapter of rate cuts, all eyes will be on how the economy responds. Will inflation continue to ease? Will the labor market stabilize? And most importantly, will the Fed manage to guide the economy toward a soft landing? Investors, businesses, and consumers alike will be paying close attention to the Fed’s words and actions in the months ahead.