On Wednesday, the Federal Reserve made its first interest rate cut since the early stages of the Covid-19 pandemic, lowering its key interest rate by half a percentage point. This move is intended to counteract a potential slowdown in the labor market as inflation and job growth both soften.
The Federal Open Market Committee (FOMC) reduced the overnight borrowing rate by 50 basis points, meeting market expectations which had shifted from predictions of a smaller cut. The last time the Fed made a half-point cut, aside from emergency Covid measures, was during the 2008 global financial crisis.
As a result, the federal funds rate now stands between 4.75% and 5%. This rate, which influences short-term borrowing costs for banks, impacts a wide range of consumer loans, such as mortgages, auto loans, and credit cards.
In addition to the rate cut, the Fed’s projections, outlined in its "dot plot," suggest an additional 50 basis points in rate reductions by the end of the year, in line with market forecasts. Looking ahead, the Fed anticipates lowering rates by a full percentage point by the end of 2025, with another half-point reduction expected in 2026. Altogether, the dot plot forecasts a total decrease of around 2 percentage points beyond Wednesday's move.
"The Committee has 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," the FOMC said in its post-meeting statement.
The decision to reduce rates came after the committee assessed progress on inflation and broader economic risks. The vote passed with an 11-1 majority, with Governor Michelle Bowman dissenting in favor of a smaller quarter-point cut.
In its economic assessment, the Fed noted that "job gains have slowed, and the unemployment rate has moved up but remains low." The committee now expects the unemployment rate to rise to 4.4% by the end of the year, up from the previous 4% projection in June.
Inflation expectations have also been adjusted, with the Fed lowering its overall inflation outlook to 2.3% and its core inflation projection to 2.6%, down slightly from June estimates.
Despite solid economic indicators like a steady rise in gross domestic product (GDP), the Fed remains concerned about inflation, which is currently running at 2.5%, still above its 2% target. However, the labor market is a growing concern for Fed Chair Jerome Powell and other policymakers, as hiring has slowed, even though layoffs remain minimal.
At a press conference in July, Powell had downplayed the possibility of a 50-basis-point cut, but shifting economic conditions led to the more aggressive stance. This move also sets the stage for future discussions on how far the Fed should go with additional cuts.
Investors’ expectations fluctuated in the days leading up to the meeting, with the likelihood of a half-point cut rising to 63% shortly before the announcement, according to the CME Group’s FedWatch tool.
The last rate reduction came in March 2020, as part of an emergency response to the economic fallout from the pandemic. The Fed began hiking rates again in March 2022 to combat soaring inflation, which had reached its highest levels in over 40 years. Over the course of its hiking campaign, the Fed implemented four consecutive 75-basis-point increases.
Although the current jobless rate has risen to 4.2%, it is still considered near full employment.
Wednesday’s decision could have a ripple effect globally, as other central banks, such as those in England, Europe, and Canada, may follow the Fed’s lead. Some have already begun cutting rates in response to global inflation, which was exacerbated by pandemic-related disruptions in supply chains and unprecedented monetary and fiscal stimulus.
While the Fed has approved the rate cut, it has continued with its "quantitative tightening" policy, gradually reducing its bond holdings. The Fed's balance sheet has decreased to $7.2 trillion, a $1.7 trillion reduction from its peak, as it allows up to $50 billion in maturing Treasurys and mortgage-backed securities to roll off each month.