Fed Rate Cut Signals Inflation Is Licked

Central bank Chair Jerome Powell hinted at additional rate cuts.

Is inflation finally licked? Are jobs and growth now economic public enemy number one?

That’s what the central bank seemed to believe in slashing the federal funds rate .5% basis points on Wednesday, its first cut since July 2020. 

The move was not surprising, even if it veered from the conventional wisdom of a 25 bps reduction little more than a week ago. A mildly encouraging Consumer Price Index, coupled with recent data showing a jobs and wider economic slowdown, however shifted the momentum with the CME Fed Watch tool forecasting a 55% probability of the larger cut in the hours leading up to the announcement. 

In its post-decision statement, the Fed noted that it had “gained greater confidence that inflation is moving sustainably toward 2 percent, and judges that the risks to achieving its employment and inflation goals are roughly in balance. But it added that “the economic outlook is uncertain.” 

The largest stock ETFs by assets under management liked the news at least initially with the $554 billion SPDR S&P 500 ETF Trust (SPY) jumping more than .5% in the immediate aftermath. The second and third largest funds, the Vanguard S&P 500 ETF (VOO) and iShares Core S&P 500 ETF (IVV), which both hold more than $500 billion in AUM and similarly track the S&P Index, moved in near lockstep.

Those funds and others relinquished most if not all those gains by the end of the U.S. trading day. 

Investors had likely already priced in the Fed’s dovishness. What’s next?

Weakening Jobs Data

In remarks to the press Wednesday, Fed Chair Jerome Powell hinted that more rate cuts might be forthcoming as the bank seeks to prevent a deeper decline of the labor market and recession. Among the latest concerning indicators, nonfarm payrolls expanded by 142,000 in August, falling short of consensus expectations. 

Powell noted that if the economy "evolves as expected, the median participant [in the policy decision] projects that interest rates could fall to 4.4% from their current range between 4.75% and 5% by the end of this year and to 3.4% by the end of 2025.

Rate decisions at their core are acts of faith–that conditions will continue on course and that a cut or increase will have a desired effect. But the current economic climate seems particularly unpredictable.

Powell also noted that the bank was “not on any preset course” and would "continue to make...decisions meeting by meeting," based on data.

With good reason.