The Federal Reserve cut interest rates by -0.50% overnight. However, the bond yields moved higher as the FOMC sees a shallower cutting cycle than was priced in to markets, and it will continue to reduce bond holdings.
The FOMC cut the Federal Funds rate by -0.50% to the 4.75% to 5.00% range.
The Fed's balance sheet will continue to be reduced by up to -$25 billion in Treasuries and -$35 billion in Mortgage-Backed Securities per month.
One FOMC member dissented, preferring a -0.25% cut. This was the first dissent since June 2022.
Chair Powell explained that the reason for cutting rates was that the risks to inflation and unemployment had become more balanced, recalling the likely overstatement of payroll gains, anecdotal evidence from the Beige Book, and other economic data.
He emphasised that the -0.50% cut was justified by the "confidence that inflation is moving sustainably toward 2%", not by significant concerns over the labour market. He also said in questions that he did not think the Fed was behind the curve and the larger move could be seen as a commitment not to get behind, rather than an indication that the Fed will rush to cut.
The Summary of Economic Projections (SEP) implies two -0.25% cuts at the remaining two meetings this year. He added that the "dot plots" should not be interpreted as a preset path for future changes.
However, the SEP also showed that Committee members expect unemployment to peak at 4.4%, up from 4.2% in June and he added that he hoped the cut would help sustain economic growth and the labour market.
The first paragraph in the accompanying statement was the only one changed from:
"Recent indicators suggest that economic activity has continued to expand at a solid pace. Job gains have moderated, and the unemployment rate has moved up but remains low. Inflation has eased over the past year but remains somewhat elevated. In recent months, there has been some further progress toward the Committee's 2 percent inflation objective" in July, to
"Recent indicators suggest that economic activity has continued to expand at a solid pace. Job gains have slowed, and the unemployment rate has moved up but remains low. Inflation has made further progress toward the Committee's 2 percent objective but remains somewhat elevated." [Emphasis added].
Australian labour market data is due out later this morning with the market expecting unemployment to remain at 4.2%.
S&P500 5,618 -0.3%, Nasdaq Comp. 17,573 -0.3, S&P/ASX200 future 8,167 -0.5%,
US 2yr 3.62% +2bps, US 10yr 3.70 +6bps
US dollar (DXY) index 100.6 -0.3%, AUDUSD 0.6764 +0.1%, Gold US$/oz 2,559 -0.4%
Fin-X Wealth View
The -0.50% move was largely priced in by last night's meeting. But there is still some disconnection between the two rate cuts that the FOMC has projected for the rest of 2024 and the three cuts priced in by the market. The market expects faster cuts next year, reaching 2.9%, compared to an FOMC projection of 3.4%.
The best way to interpret this difference is probably that the Federal Reserve may stick the "soft landing" with unemployment peaking around 4.4%. However, the market is also pricing a significant probability that unemployment will continue to rise significantly above that level, as it has done in previous cycles.
At the moment, the Fed is comfortable that the labour market has softened enough not to be a source of inflation as hiring has slowed and layoffs have not been material. Chair Powell likened conditions to 2017/18. If layoffs start to increase, the Fed will likely cut faster and bond yields still have room to move lower.
It is also worth noting that Treasuries are pricing almost zero risk that inflation will pick up again. 10yr breakeven inflation is at 2.1%, very close to the 2% target. If inflation does firm up for whatever reason yields would likely move sharply higher. We attach a low probability to this scenario, but will be watching how house prices and rents respond to today's cut.
Source: Bloomberg, Federal Reserve, 19th September 2024
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