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What prompted the Fed to start its monetary easing with a bang?

The Federal Open Market Committee cut interest rates yesterday by 50 basis points, lowering the target range for the federal funds rate to 4.75% to 5.00%. Aside from pricing the market for more than half of this move, the reason for the big start was in the monetary policy statement that explained: "Inflation has improved, and the labor market has deteriorated enough to warrant greater action (more than 25 basis points). "The committee has gained greater confidence that inflation is moving sustainably towards 2 percent, and considers the risks to achieving its employment and inflation targets to be roughly balanced," the statement said. In the July statement, confidence had not yet been gained and risks were only moving towards equilibrium. "The committee is strongly committed to supporting maximum employment and bringing inflation back to its 2% target," the new statement said.

The future guidance from the July statement was essentially reiterated: "When considering additional adjustments to the target range of the federal funds rate, the committee will carefully evaluate the data received, evolving expectations, and the balance of risks." There was one opposition, with Governor Bowman backing a measure of only 25 basis points yesterday.

Further cuts were indicated, with the SEP and its Dot Plot showing that the FOMC median forecast showed further cuts of 50 basis points for this year to the midpoint of the 4.375% range, 100 basis points next year to 3.375%, and 50 basis points in 2026 to 2.875%. The latter considered the new and higher neutral level in the longer term, which was raised by 12.5 basis points. Interestingly, yesterday's 50 basis point rate cut and the 100 basis points total of monetary easing this year seemed to have been a unified decision. There were 10 participants expecting to cut cumulative interest rates by at least 100 basis points (only one at 125 basis points) and nine expecting 75 basis points or less (with two calling for no further action).

The average economic outlook has been revised as expected. For the fourth quarter of 2024, real GDP growth was revised to 2.0% year-on-year and the unemployment rate was revised to 4.4%. Gross and core inflation in personal consumption expenditures was reduced to 2.3% year-on-year and 2.6% (down 0.3 basis points and 0.2 basis points respectively). The unemployment rate rose by 0.2 basis points in 2025 and 2026, to 4.4% and 4.3%, respectively – now above the normal level of 4.2%. Inflation returns to the 2% target by the fourth quarter of 2026 as before.

At the press conference, Fed Chairman Powell said that policy is not on a "predetermined path" and will be determined on a "meeting after meeting" basis. The biggest belief is that the track will be 25 basis points per meeting until March. The Fed cut emergency interest rates by 50 basis points to a new upper limit of the Fed's 5% funds target range in a non-emergency environment, unlike the last two times it decided to cut interest rates significantly (2001 and 2007).

How can we explain why the Committee increased the size of the first interest rate cut and significantly increased the amount of easing expected throughout 2025, while presenting the same GDP growth forecasts throughout the entire forecast period and with a higher unemployment rate than they previously expected? Perhaps the strong signal from the committee is that they are more concerned about the risks to the outlook for the US economy and seek to address them more easingly.

Thus, the best question to ask at the press conference would have been, "Why do you see the same economy with a higher unemployment rate despite the committee shifting towards more easing than previously directed?" President Powell escaped the need to answer the real reason behind the start of the drastic reduction and the need to explain what they see or fear about the outlook, which would have helped markets better understand their thinking while formulating their own forecasts. Josh Emanuel, chief investment officer at Wilshire said: "Despite what President Powell said at the press conference, the 50-basis point move suggests there are concerns that they are lagging behind the curve."

The Fed's actions suggest that it has seen a shift in the risk balance around inflation and employment, justifying a faster adjustment toward neutrality than many officials previously thought. Historically, given the Fed's decisions since the mid-twentieth century, an initial 50-basis-point rate cut has typically preceded or signaled a recession mitigation cycle – a more severe, deep, or prolonged series of interest-rate cuts aimed at supporting a struggling economy.

But it is clear that the U.S. economy is not currently in recession; consumer spending remains resilient, and investment growth appears to be accelerating. However, with inflationary pressures receding, the Fed appears to be focused on ensuring that U.S. growth and labor markets remain strong by aligning monetary policy with today's economy – which looks more "normal" now that the series of pandemic-related shocks that have led to higher inflation has largely subsided.

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What prompted the Fed to start its monetary easing with a bang?

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What prompted the Fed to start its monetary easing with a bang?

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