Fed cuts interest rates by half a point, initiating easing campaign amid economic concerns

The Federal Reserve has taken a significant step in its monetary policy by cutting interest rates by half a percentage point, marking its first reduction since the onset of the Covid pandemic. This decision, made on Wednesday, aims to mitigate potential downturns in the labor market while responding to easing inflationary pressures as detailed in a report by CNBC.

In a move that aligns with recent market forecasts, the Federal Open Market Committee (FOMC) reduced the benchmark federal funds rate to a range of 4.75 per cent to 5 per cent. This marks a notable shift from the emergency rate cuts implemented during the pandemic, with the last half-point cut occurring in 2008 during the global financial crisis.

"The Committee has gained greater confidence that inflation is moving sustainably toward 2 per cent, and judges that the risks to achieving its employment and inflation goals are roughly in balance," the Federal Reserve statement said.

The FOMC's decision comes amid signs of easing in both employment data and inflation. The committee's post-meeting statement indicated that it has gained confidence in achieving its employment and inflation goals, despite ongoing concerns about the labor market. Further, the vote to lower rates was not unanimous; Governor Michelle Bowman advocated for a more conservative quarter-point reduction.

Economic indicators have shown mixed signals, with the unemployment rate projected to rise to 4.4 per cent this year, up from an earlier estimate of 4 per cent. Concurrently, the inflation forecast has been adjusted downwards from 2.6 per cent to 2.3 per cent, reflecting a cautious approach by the Fed in navigating these economic challenges.

What does the Fed 'dot plot' suggest?

The FOMC's 'dot plot' suggests that additional cuts could be on the horizon, with another potential reduction of 50 basis points expected by year-end. Overall, projections indicate a total reduction of one full percentage point by the end of 2025, with an additional half-point decrease anticipated in 2026.

Despite these adjustments, concerns about the labor market persist. While layoffs have not surged dramatically, hiring has slowed significantly, with recent monthly hiring rates dropping to levels not seen since unemployment rates exceeded 6 per cent. Chair Jerome Powell and other officials have voiced worries about this trend, indicating that vigilance is required as economic conditions evolve.

Investor sentiment leading up to the meeting fluctuated considerably, with expectations for a half-point cut rising to 63 per cent according to CME Group's FedWatch tool. This decision is likely to have broader implications for global monetary policy as central banks in the United Kingdom, Europe, and Canada have also begun reducing rates in response to similar economic pressures.

The Fed's current approach reflects its ongoing struggle to balance economic growth with inflation control. While gross domestic product continues to grow projected at approximately 3 per cent for the third quarter, many indicators suggest that inflation remains above-desired levels. The Fed's preferred measure indicates inflation at around 2.5 per cent, still higher than its target of 2 per cent.

As part of its strategy, the Federal Reserve is also maintaining a program aimed at gradually reducing its bond holdings through quantitative tightening. This process has decreased its balance sheet to $7.2 trillion, down approximately $1 trillion from its peak.

Hence, Wednesday's decision marks a pivotal moment for the Federal Reserve as it embarks on an easing campaign amidst economic uncertainty. With potential further cuts on the horizon and ongoing assessments of labor market dynamics, all eyes will be on how these changes influence both domestic and global economic landscapes in the coming months.

What is the way forward for the Reserve Bank of India?

According to a report by Emkay Global titled "Fed kicks off with a bang, but pace to moderate", released on September 19, the prominent brokerage firm believes that this cut by the Federal Reserve will give room for the emerging markets in Asia to take informed and calculated calls for their easing cycles, "This outsized cut has given emerging markets inAsia room to proceed with their own easing cycles, with the Bank of Indonesia delivering a 25bps cut earlier in the day. With the global market reaction having been muted thus far, the RBI still has the flexibility to remain focused on domestic inflation and risk management, albeit there are over 20 days before its next MPC meeting. The RBI is likely to maintain its wait-and-watch stance and focus on being ‘actively disinflationary’, with a first-rate cut likely by December. A case for an early cut is still less likely, and we continue to see shallow cuts by both the Fed and the RBI in this cycle."