U.S. Federal Reserve chairman Jerome Powell holds a press conference in Washington, DC, on Sept. 18. The Federal Reserve cut its key lending rate by half a percentage-point Wednesday in its first reduction since the pandemic.MANDEL NGAN/AFP/Getty Images
The U.S. Federal Reserve has kicked off its first easing cycle in four years with a bang, cutting interest rates by an unusually large half percentage-point and signalling more reductions ahead.
Policy makers at the world’s most important central bank voted Wednesday to lower the benchmark federal funds rate to a range of 4.75 per cent to 5 per cent. They also published a new forecast showing they expect the policy rate to fall another half percentage point by the end of the year, and a further full percentage point next year.
The move marks a key turning point in the global fight against inflation, which surged in the wake of the pandemic, prompting a barrage of rate hikes from central banks in 2022 and 2023.
The Fed had kept its benchmark overnight rate at a 23-year high since last summer, standing pat while other central banks, including the Bank of Canada, started easing monetary policy. That was partly owing to the relative strength of the U.S. economy and stubbornness of inflation. But in recent months, the Fed’s highly restrictive interest rates have seemed out of touch with declining inflation and a softening in the U.S. labour market.
Fed Chair Jerome Powell said Wednesday’s oversized move was not prompted by concerns about economic weakness. High interest rates are no longer appropriate given the changing economic conditions, he said, and the Fed wanted to move decisively to start bringing them back to a more neutral level.
“The US economy is in a good place, and our decision today is designed to keep it there,” he said in a press conference after the rate announcement. “You can take our 50 basis point move as a commitment to make sure that we don’t fall behind.”
The annual rate of inflation in the U.S. has fallen to 2.5 per cent in August, down from a high of 9.1 per cent in 2022. As the Fed has become more confident it can bring inflation back to its 2-per-cent target, its focus has shifted to the other side of its dual mandate: maintaining maximum sustainable employment.
At 4.2 per cent, the unemployment rate in the U.S. is still relatively low by historical standards. But it has moved up almost a percentage point over the past year, and there are other signs the labour market is weakening, including a pull-back in hiring.
Mr. Powell said the upside risks to inflation and downside risks to employment are roughly “balanced.” However the Fed’s choice to frontload its easing cycle with a half-point cut led some economists to speculate that policy makers are more worried about the U.S. economy than they are letting on.
“The strong signal from the committee is probably that they are more concerned about the risks facing the outlook for the US economy and seeking to counter them with more easing. That to me is a negative signalling effect if ever I’ve seen one,” wrote Derek Holt, head of capital market economics at Bank of Nova Scotia, in a note to clients.
Michelle Bowman, one of the Federal Open Market Committee’s 12 decision-makers, voted against the half-point move, advising a quarter-point cut instead. This is the first dissenting vote from a Fed governor since 2005.
While initially rallying on the Fed rate cut, U.S. and Canadian stocks closed with modest losses. A brief dip in North American bond yields also didn’t last long, with yields across the curve higher on the day by late afternoon.
The benchmark S&P 500 index rose as much as 1 per cent after the announcement, before paring gains to close down 0.29 per cent. The S&P/TSX Composite Index ended down 0.36 per cent. Some of the last-minute decline in stocks was blamed simply on investors taking profits, given monetary easing was already priced into markets. The S&P 500 is up nearly 18 per cent this year.
Policy catch-up appears needed as U.S. Federal Reserve’s shift to job market risks is done
There was an unusual amount of uncertainty ahead of the decision. Economists and investors universally expected a cut, but it was unclear how big the central bank would go, with markets largely discounting the possibility of a half-point cut until last week, then rapidly coming around to the idea in recent days.
The decision was made at a sensitive political moment ahead of November’s U.S. presidential election. Falling interest rates could boost consumer confidence, improving the odds for the Democratic Party nominee, Kamala Harris. Republican nominee Donald Trump had called for the Fed to hold off cutting interest rates ahead of the decision.
Mr. Powell, who was appointed by Mr. Trump in 2018, said the Fed’s decision was not influenced by political considerations.
“We do our work to serve all Americans. We’re not serving any politician, any political figure, any cause, any issue, nothing. It’s just maximum employment and price stability,” he said.
The new “dot plot” published Wednesday, where FOMC members write down where they think the policy rate will be over the next three years, suggests a steady stream of rate cuts in the coming quarters.
Officials saw the policy rate declining to a range of 4.25 per cent to 4.5 per cent by the end of 2024. That implies either one more half-point cut or two quarter-point cuts at the Fed meetings in November and December. The median forecast then shows the federal funds rate falling to a range of 3.25 per cent to 3.5 per cent by the end of 2025, and settling at a range of 2.75 per cent to 3 per cent by the end of 2026.
Because of the size and importance of U.S. financial markets, the Fed’s decision will reverberate around the world and could influence monetary policy in other countries, including in Canada.
“It cuts both ways. The Fed moving more aggressively will help protect the US economy from greater downside, which is a plus for the Canadian economy,” said Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce, in an interview.
“But it also shores up the Canadian dollar and allows more elbow room for the Bank of Canada to cut without worrying about the exchange rate.”
After the U.S. rate announcement, money markets upped their bets that the Bank of Canada will announce its own half-point cut at its next policy meeting on Oct. 23. Implied probabilities in swaps markets are now pricing in about 55-per-cent odds of that happening, up from 46 per cent before Wednesday’s announcement, according to LSEG data.
With reports from Darcy Keith
Editor’s note: (Sept. 19, 2024): A previous version of this article incorrectly stated that Michelle Bowman’s dissent was the first on the FOMC since 2005. It was the first dissenting vote from a Fed governor since 2005. This version has been updated.