In a widely anticipated move, the Federal Reserve announced on Sept. 18, 2024, that it was cutting its benchmark interest rate by half a percentage point to a range of 4.75% to 5% – the first time the cost of borrowing has been lowered in four years.
The move marks an important pivot point, signaling that central bankers believe they have finally won their battle against inflation. It is also significant in timing, coming just months before the U.S. heads to the polls in a tight election that could turn on how Americans feel the economy is going.
What does the Fed rate cut suggest about the state of the economy?
The Federal Reserve has two mandates: to pin inflation to around its target of 2% and to keep unemployment low. And the central bank balances that twin mandate when looking at whether to raise or lower base rates, or keep them the same.
For some time now, policymakers have concentrated on trying to get inflation under control through a series of interest rate hikes that took the Fed’s benchmark or base rate from a range of 0% to 0.25% in early 2022 to 5.25% to 5.5% in September 2024.
I believe what motivated them to drop the rate by a half-point now – rather than the quarter-point that some were expecting – is the labor market. The labor market is not exactly shaky – unemployment is currently at 4.2% – but it isn’t as robust as it was.
The latest job numbers were a little below expectations. And some economists are saying that there is a recession ahead. Indeed, there are some that are saying the U.S. is already in a recession.
So my guess is the majority of the Fed’s rate-setting board were convinced more by the latest unemployment data than inflation. In terms of the dual mandate, the Fed clearly feels it’s got the inflation fight in the bag, so it has turned to its second concern of keeping unemployment low.
So is this the soft landing the Fed was hoping for?
I would say so, yes. We are now in a soft landing – and I forecast the U.S. economy to slow but avoid a recession.
If I am right, then that is an achievement of Fed policy. A soft landing is very unusual – I can think of only one other occasion when it has occurred since the end of World War II. That was in mid-1995. And the story goes that then-Fed chair Alan Greenspan, during his daily soak in a tub for a bad back, became worried about the prospect of significantly higher prices. He proceeded to convince the Fed board to raise rates, which it did – a move that headed off a potential recession.
What impact will the rate cut have?
The first thing to note is that this will not mean we are returning back to 2019 prices – that would take wage cuts and deflation. This will merely slow inflation, or the rate at which prices rise.
But it will have an impact. In the first hour after the decision was made, stock markets jumped on the news – so investors were clearly happy – though the major indices ended the day lower.
Investment markets tend to anticipate any expected change, so we have already seen some lowering of mortgage rates – which have been trending down in the run-up to the Fed decision. Credit card interest rates have been trending down, too.
So the markets were clearly expecting a Fed rate cut. But we should see further drops in mortgage rates because the Fed has hinted at more interest rate cuts to come.
Is there a danger that some observers will see this as a political move?
I’m sure a lot of people will read this as Fed Chair Jay Powell helping the Democrats by cutting rates before the election.
But this is an economic-driven decision. There is no evidence that this has anything to do with the election.
What does history tell us about rate cuts and elections?
I think most serious observers know that the Fed is independent and makes decisions based purely on what is best for the economy. In fact, over the past 50 years, you will only find one period when eyebrows were raised. That was during the Nixon administration.
Under Fed Chair Arthur Burns, the central bank was accused of pumping money in the the system and cutting rates to make things look prosperous in advance of the 1972 election. But it later all blew up when the U.S. headed into a period of double-digit inflation.
Aside from that, you will be hard-pressed to find real evidence of interference. In fact, since then, presidential candidates from both parties have complained about the Fed.
Nonetheless, could the rate cut play into the election campaign?
In terms of how Americans feel about the economy? Not really. I don’t think mortgage rates will drop much more. And although the news is encouraging for borrowers, there is another side of rate cuts: They are negative for some types of investors. Money market investors, for example, will not look upon the Fed move so fondly.
But that doesn’t mean the two presidential tickets won’t try to turn the news to their benefit.
Democrats will happily take any credit for getting inflation back down on their watch and will point out how it will help Americans with home loans – avoiding the fact that they don’t actually have any role in the rate decisions themselves.
Meanwhile, Republicans might well say: “Hey, the Fed dropped rates because the economy is worse than we thought. And a half-point cut means they are desperate, the economy is horrible and we are heading for recession because of the Biden administrations’s policies.”
