The Fed cut interest rates by 0.50% at its Federal Open Market Committee meeting last week. The market expected a cut but was unsure by how much. The debate between a 0.25% and a 0.50% cut dominated headlines over the past week, but it was mostly noise and likely won’t have a significant long-term impact. Now that the first cut is complete, the focus shifts to how much and how quickly the Fed will continue to cut rates
Chairman Powell offered little guidance, describing the outsized rate cut as a recalibration. The Fed’s Summary of Economic Projections provides more insight into its current thinking, particularly the median estimate of the longer-run Fed funds rate. This estimate serves as a proxy for the neutral rate, the theoretical interest rate that neither stimulates nor restricts the economy.
Officials previously estimated the neutral rate at 2.5%, but this year, the median estimate has risen from 2.5% in January to 2.9% in September. The Fed is signaling to investors that it believes the neutral rate is higher than it was before the pandemic. This has significant implications, as Chairman Powell has repeatedly expressed a desire to return to the neutral rate.
The markets will be focused on economic data for the next several quarters. We believe the economy’s trajectory will determine how much and how fast the Fed continues to cut. A recession or sharp slowdown may lead to more frequent and deeper cuts, while a growing economy may lead to fewer cuts at a slower pace.
Economic data will become more important in the coming months, and the market will likely overreact to each data point until a trend emerges. Within the next six months, the data should provide evidence that illustrates rate cuts are stimulating the economy, or the lag from monetary policy is slowing the economy.
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