On Wednesday, Chairman Powell announced that the FOMC voted to reduce the Fed Funds Rate by 50bps, bringing the target range down to 4.75%-5.00%. Coming into the meeting, market participants were at odds on whether policy makers would implement a 25bps or a 50bps reduction, with the latter move thought to potentially signal a more aggressive Fed that is behind the curve. However, Chair Powell successfully staved off hard landing concerns by reiterating that the FOMC remains confident in both economic growth as well as the progress they’ve made on inflation, which is down well below its 9% peak.
At this meeting, we received an updated Summary of Economic Projections (SEP) from the FOMC. Most notable was the median projection for the unemployment rate at year-end 2024 rising to 4.4%, vs June’s projection of 4.2%. Additionally, the median projection for total PCE inflation at year-end is now 2.3%, lower than in June. Consistent with Powell’s statements, the FOMC believes upside risks to inflation have diminished and downside risks to employment have increased. Therefore, in order to maintain economic growth and healthy labor markets, the committee thought it prudent to recalibrate policy and began the move towards a more neutral stance. Based on the Fed’s Summary of Economic Projections, the median forecast for the target fed funds rate is for an additional 50bps of cuts this year, a more dovish rate path than previously anticipated. Markets were choppy throughout the meeting, with an abrupt selloff occurring as Powell mentioned that we are most likely not returning to the era of ultra-low interest rates. However, on the Thursday following the meeting, the S&P 500 made an all-time high, while the NASADAQ gained 2.5%, a notable outperformer. The risk-on tone in the market was undeniable, as small caps and cyclicals rallied at the expense of defensive names. Overall, the soft-landing narrative seemed to dominate consensus once more, resulting in a broad participation across the markets.
Currently, yields on 2-year bonds are well below the Fed’s target range, suggesting that the market believes monetary policy is “too tight.” We believe this gap between 2-year bond yields and the Fed Funds Rate is likely to close – either the Fed could begin reducing policy more or the market could start pricing in higher yields. The former could occur more aggressively if weaker economic data, specifically within the labor market, begins to emerge. The latter could occur if we see a reacceleration in inflation or more persistent inflationary pressures. Neither circumstance would bode well for markets. Rates rising or falling too fast would be bearish, as rate stability is more important than the actual level. However, a slow convergence between the Fed Funds Rate and 2-year yields amid stable economic data and lower inflation would be preferred – in other words, a soft landing.
Although inflation has come down meaningfully, the labor market is weakening and bears close watching. The downside to employment typically has a snowball effect once momentum starts to build. As Powell stated, the message behind Wednesday’s cut is that the FOMC is committed to not getting behind the curve. For the first time in a long time, it seems as though the Fed is being proactive instead of reactive, which appears to be a welcomed change. As such, the weight of the evidence continues to support a soft landing.
Source: Factset, Federal Reserve, Reuters, Yahoo!finance
By Veronica Fulton, CFA, Associate Portfolio Manager
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