09/18/2024
Federal Reserve Meeting Today
Currently, market participants are closely monitoring the Federal Reserve’s potential actions regarding interest rate cuts. According to CME Group’s FedWatch tool, there is significant probability assigned to rate cuts of varying magnitudes in upcoming meetings. Investors have priced in expectations for substantial reductions in the federal funds rate by the end of 2024, indicating anticipation of one or possibly two 50-basis-point cuts in the final three Fed meetings of the year, starting with this week. This expectation stems from the belief that inflation has moderated sufficiently, allowing policymakers to shift their focus toward preventing further softening in the labor market.
The stock market’s reaction will hinge not only on the size of any rate cut but also on the Federal Reserve’s new economic projections, which are scheduled for release at 2 p.m., and on Fed Chair Jerome Powell’s remarks during his 2:30 p.m. news conference.
Monetary policy plays a critical role in shaping economic conditions. By adjusting the federal funds rate, the Federal Reserve influences borrowing costs for consumers and businesses, which in turn affects spending, investment, and overall economic growth. Lowering interest rates can stimulate economic activity by making loans more affordable, encouraging businesses to expand and consumers to spend. Conversely, raising rates can help curb inflation by making borrowing more expensive, thus slowing down economic activity.
Here is what we are on the lookout for:
Recent indicators on inflation and treasury yields
Over the period, nominal Treasury yields declined, with shorter-term yields decreasing more than longer-term yields, resulting in a steepening of the yield curve. Treasury yields remained sensitive to unexpected economic data, particularly consumer price index releases and employment reports. While near-term inflation compensation fell during last few intermeeting periods, longer-term forward measures remained largely unchanged. Measures of inflation expectations derived from term structure models were modestly lower.
PCE, unemployment, and GDP
Consumer price inflation as measured by the 12-month change in the Personal Consumption Expenditures (PCE) price index remained approximately the same in June as at the start of the year. However, the month-over-month changes in May and June were smaller than those observed earlier in the year. Total PCE price inflation was 2.5 percent in June, while core PCE price inflation which excludes energy prices and many consumer food prices stood at 2.6 percent. Since the last meeting, PCE inflation has held steady at 2.5 percent. Meanwhile, unemployment has ticked up to 4.2 percent, and GDP growth is now at 3.0 percent.
Economic Forecast
The economic forecast prepared by the staff for the July meeting indicated a lower rate of resource utilization over the projection period compared to the forecast from the previous meeting. The staff’s outlook for growth in the second half of 2024 was revised downward, largely due to weaker-than-expected labor market indicators. Consequently, the output gap at the start of 2025 was projected to be somewhat narrower than previously anticipated, although still not fully closed. It remains to be seen whether the committee still considers this a possibility or if further trends will need to be studied.
Rate Cut Decision
The Federal Reserve (Fed) uses monetary policy tools, such as adjusting the federal funds rate, to influence economic conditions and achieve its dual mandate of maximum employment and price stability. When economic indicators suggest the need for stimulus, the Fed may consider cutting interest rates to encourage borrowing and investment.
Some Factors that influence the Rate Cut Decision
1. Inflationary Trends: If inflation is below the Fed’s 2% target, a larger rate cut (50 bps) might be warranted to stimulate economic activity and push inflation toward the target.
2. Labor Market Conditions: An uptick in unemployment rates (e.g., the movement from 3.8% to 4.2%) may prompt the Fed to consider a more aggressive cut to prevent further labor market softening.
3. Economic Growth Outlook: A decrease in GDP growth projections (the movement down to 3.0%) could influence the Fed to opt for a larger cut to spur economic activity.
50 bps vs. 25 bps
50bps
Pros:
Provides a strong signal of the Fed’s commitment to supporting the economy.
Can lead to a more immediate reduction in borrowing costs for consumers and businesses.
May boost confidence in financial markets.
Cons:
Risks over-stimulating the economy, potentially leading to inflationary pressures.
Reduces the Fed’s monetary policy ammunition for future downturns.
25bps
Pros:
Offers a measured approach to easing monetary policy.
Allows the Fed to assess the impact of the cut before making further adjustments.
Balances the need for stimulus with concerns about financial stability.
Cons:
May be perceived as insufficient by markets expecting more aggressive action.
Could have a limited immediate impact on economic activity.
The decision between a 50 bps or a 25 bps rate cut depends on a complex assessment of economic data, inflation trends, labor market conditions, and financial market expectations. The Federal Reserve aims to calibrate its policy actions to support sustained economic expansion while keeping inflation near its target.
