Federal Reserve cuts interest rates for first time in 4 years

of Federal Reserve System The central bank announced a much-needed interest rate cut on Wednesday, slashing borrowing costs following progress in battling inflation, slashing its policy rate by 50 basis points from its highest level in 23 years.

The Fed’s first rate cut since March 2020 will bring the benchmark federal funds rate to a range of 4.75% to 5%.

Interest rates have been hovering in a range of 5.25% to 5.5% since July 2023, the highest level since 2001, as the central bank looks for signs that stubborn inflation is heading towards its 2% target.

While recent months have shown signs of progress in moving inflation toward the Fed’s target, the latest data suggests we’re not there yet. Inflation slowed to 2.5% year-over-year in August, down from 2.9% the previous month and well below this inflation cycle’s peak of 9.1% in June 2022.

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Federal Reserve Chairman Jerome Powell At a press conference after the announcement, he said the central bank was focused on “achieving our twin mission of maximum employment and stable prices for the benefit of the American people.”

“Our economy is performing well overall and we have made significant progress toward our objectives over the past two years,” Powell said. “Today’s decision reflects our growing confidence that, with an appropriate recalibration of the policy stance, we can sustain labor market strength in the context of moderate growth and inflation declining sustainably to 2 percent.”

Regarding the decision to cut rates by 50 basis points, Chairman Powell said, “I don’t think we’re behind. I think this is timely, but I think you can also take this as a signal of our determination not to fall behind.”

Inflation rises by less than expected 2.5% in August

The chairman emphasized that the Fed will make decisions at each meeting going forward based on economic data, saying, “We can act more quickly if it’s appropriate, we can act slower if it’s appropriate, or we can pause if it’s appropriate. That’s what we’re considering.”

He was also asked about the political ramifications of cutting interest rates, with Election Day less than two months away. Powell said Fed policymakers are focused on “how best to support the economy on behalf of the American people,” noting that the Fed’s actions often have a delayed effect on economic conditions after policy changes.

“We don’t see anything right now that suggests a downturn in the economy is increasingly likely,” Powell said in response to a question about whether the economy is prone to a recession. “I don’t think so. Economic growth is strong, inflation is declining and the labor market remains in very strong condition.”

Chairman Powell said the Fed is confident about the economy’s progress toward containing inflation. (Photo courtesy of MANDEL NGAN/AFP via Getty Images/Getty Images)

Powell has previously suggested the central bank doesn’t want to wait until inflation hits 2% before cutting interest rates.

“If we wait until inflation gets down to 2 percent, we’ve probably waited too long, because the tightening, or the level of monetary tightening that we’re currently experiencing, is probably still having the effect of pushing inflation below 2 percent,” he explained in July.

a Slowing employment Growing concerns about the labor market and economy potentially tipping into a recession have led to speculation the Fed could opt to cut interest rates by 50 basis points.

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The central bank typically chooses to make small cuts of around 25 basis points at the start of a rate-cutting cycle but has made larger cuts at times of heightened economic uncertainty.

Most recently, it opted to make large 50 basis point cuts in interest rates in March 2020 at the start of the COVID-19 pandemic, in September 2007 during the housing crisis, and in January 2001 when the dot-com bubble burst.

The Fed has previously signaled that policymakers will not wait until inflation hits 2% before lowering interest rates. (Photographer: Ting Sheng/Bloomberg via Getty Images/Getty Images)

The market had fully priced in a 25 basis point rate cut ahead of the Fed’s decision on Wednesday, but traders were increasingly betting the Fed would cut rates by 50 basis points ahead of the announcement.

According to the CME FedWatch tool, the probability of a 50 basis point cut rose to 64% the day before the Fed’s decision from 25% a month ago.

Wednesday’s rate cut is expected to be the first in a series of interest rate cuts. Prior to the Fed’s announcement, the market had been expecting the central bank to announce further rate cuts at its meetings in the coming months. The CME FedWatch tool gives a slightly more than 50% chance of a rate cut to the 4.5% to 4.75% range in November.

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“The market got what it wanted: the first big Fed rate cut,” said Chris Larkin, managing director of E*TRADE trading and investing at Morgan Stanley. “More than a question of whether the economy is doing well or not, a lot will depend on whether the Fed gives guidance on how quickly and how much they’re going to cut rates going forward.”

The stock market responded favorably to the Fed’s decision to cut interest rates, with both the Dow Jones Industrial Average and the S&P 500 hitting all-time highs shortly after the announcement before Chairman Powell’s press conference.

The Federal Reserve’s next policy meeting will be held on Nov. 6-7, just after Election Day on Nov. 5, and its final meeting of the year will be held on Dec. 17-18.