The US Federal Reserve has confirmed a change of cycle on Wednesday. The US central bank has approved the first interest rate cut in four and a half years. Its president, Jerome Powell, had already clearly indicated that the time had come, the crucial turning point at which monetary policy goes from fighting inflation to trying to avoid a recession. The cut was taken for granted, but the unknown was the amount. Finally, Powell has opted for an aggressive reduction of 0.5 points, to the range of 4.75%-5%. In addition, the members of the Fed anticipate that there will be more imminent cuts, leaving rates at 4.25%-4.5% at the end of the year, which implies two more reductions of 0.25 points at the meetings in November and December.
There were arguments for a more aggressive or a more moderate increase, but the important thing is the change in direction of monetary policy, in search of the difficult and longed-for soft landing of the economy (controlling inflation without causing a recession). Interest rate cuts stimulate activity, by making it cheaper to borrow to invest or consume or by leaving more disposable income for this. They make mortgages cheaper, reduce the interest burden on credit cards and personal loans. Conversely, they imply a lower return on deposits.
In recent days, investors had been mostly betting on a 0.50 point cut, but last week they were leaning towards 0.25. The Fed had left the market somewhat blind, unlike what happened at meetings in recent years. The announcement has caused a sharp rise in the stock market. An aggressive cut provides greater protection against a recession. Once the central bank was clear that it had to lower rates by at least one point in a few months, it could afford to speed up, especially after having waited at the July meeting.
Now, with the upcoming meetings approaching, investors have new data to recalculate the route. As happens at each final meeting of the quarter, the members of the Federal Reserve have published their forecasts of where they think the unemployment rate, economic growth, inflation and interest rates will be at the end of this year and in the next few years. The forecasts paint a scenario of a soft landing in terms of economic indicators (unemployment of 4.4% and inflation of 2.3% at the end of the year) and of additional reductions in terms of interest rates. The members of the Federal Reserve expect them to be in the range of 4.25%-4.5%, which would imply, for example, two more rate cuts of 0.25 points at the meetings in November and December.
“Recent indicators suggest that economic activity has continued to grow at a good pace. Employment growth has slowed and the unemployment rate has risen but remains low. Inflation has continued to move toward the Committee’s 2% target but remains somewhat elevated,” says the Federal Reserve statement. “The Committee has gained confidence that inflation is moving sustainably toward 2% and considers the risks to the achievement of its employment and inflation objectives to be roughly balanced,” it added.
The decision was not unanimous. Michelle Bowman, representing the Federal Reserve of Kansas City, voted against because she preferred a more modest cut of 0.25 points. Powell will appear at 2:30 p.m. in Washington (8:30 p.m. in mainland Spain) to explain the central bank’s decision.
Such an aggressive move less than two months before the elections could provoke political opposition. Some Democratic senators had asked for a reduction of 0.75 points, while Donald Trump rejects any reduction in the price of money before the polls.
Change of sign
Faced with inflation that turned out to be less transitory than expected, the Federal Reserve implemented its most aggressive rate hikes in four decades. Between March 2022 and July 2023, it approved 11 money price increases, taking the federal funds rate from near zero to the 5.25%-5.5% range it had been in until now. This was the highest level since January 2021.
After those 11 rate hikes, Powell has decided for more than a year that the best thing to do was to do nothing. Rates have not moved since July of last year, despite the fact that the market was betting on a much earlier relaxation of monetary policy. The persistence of inflation, with ugly data at the beginning of this year, weighed more on Powell’s mood than the progressive weakening of the labor market, especially while the unemployment rate remained below 4% and the inflation rate above 3%.
For several months now, however, the balance of risks to the central bank’s dual mandate (price stability and maximum possible employment) has been rebalancing until, recently, alarm bells have been ringing in the labor market while inflation has been contained. Some leading indicators have indicated that the United States is on the verge of or entering a recession, although the world’s largest economy has been defying these bad omens for more than two years.
Whether the risk of recession is greater or lesser, it was time to act. Indeed, some members of the Federal Reserve already showed a tendency to lower rates at the July meeting, as the minutes later revealed. A few months before or after, Powell’s message is precisely that a turning point has been reached. He takes action when inflation has fallen to 2.5% and unemployment has risen to 4.2%, but with recent trajectories in the opposite direction. The president of the Federal Reserve preferred to err on the side of caution with inflation, even at the cost of waiting a little longer than necessary.
The first movement
At times, Powell has pointed out the importance he attached to this first move and how he needed to be sure that it was the right move. If he eased off too soon, he was worried about the loss of authority that would come with having to raise rates again within a few months of having lowered them. And, above all, the ghost of history. Arthur Burns, chairman of the Federal Reserve between 1970 and 1978, was tolerant of inflation, he considered the battle won early and price increases became entrenched in the US economy for a decade. It was his successor, Paul Volcker, who put a stop to inflation with aggressive rate hikes that caused a recession. Powell, an admirer of the latter, was willing to pay that price, although for now he has managed to avoid it.
With Wednesday’s decision, the US Federal Reserve joins other central banks around the world that have already begun the process of relaxing monetary policy in the wake of the global inflation crisis. The European Central Bank (ECB) cut interest rates for the second time last week. The Bank of England also lowered the price of money last month, although a pause is expected at its meeting on Thursday. The central banks of Canada, New Zealand, Mexico and China, among others, are also relaxing their monetary policy. The main exception is Japan, which recently raised rates, although they remain at very low levels. A change of pace is also expected in Brazil in the face of rising inflation.
The reduction in the reference interest rates of the dollar has global implications. Since it is the main reference currency, this reduction contributes to easing global financial conditions and leaves more room for countries to lower their rates themselves, without so much fear of capital flight. The change in cycle also has implications for currencies (the euro has appreciated to 1.12 dollars) and raw materials. And, of course, for the stock markets, both because it makes financing corporate debt cheaper, and, above all, because rates are essential when it comes to making stock market valuations.
[Noticia de última hora. Habrá actualización en breve]
#Federal #Reserve #cuts #interest #rates #points #plans #additional #cuts #year