Fed cuts 50bps to 5%
It finally happened. After 14 months at peak rates, the Fed cut rates by 50bps yesterday, lowering the fed funds rate to 5% from 5.5%.
Weakening labor market pushed Fed from no cut in July to jumbo cut in September
Going for a jumbo 50bps cut yesterday might seem strange since the Fed left rates unchanged at their last meeting just seven weeks ago. So what changed?
The labor market.
At the time of the Fed’s July meeting (left chart below), the economy had been adding +177k jobs per month. By September (right chart below), after annual revisions and two weaker jobs reports, that number dropped to +116k.
With the labor market clearly cooling (but not collapsing), the Fed seemed to realize they should have cut 25bps in July. So to catch up, they did 50bps in September (chart below, darker red line).
Fed sees 200bps more in cuts by 2026, markets see 200bps by 2025
The good news is that with inflation trending down, the Fed has room to cut to (hopefully) ensure the labor market doesn’t worsen materially from here.
The Fed’s projecting (orange dots) another 50bps in cuts this year (25 per meeting), 100bps next year, and another 50bps in 2026. That would get the fed funds rate down to 3% — the Fed’s estimated “neutral rate,” which neither slows nor boosts the economy.
Markets also see the Fed getting rates down to 3% (lighter red line), but by the end of next year, with 75bps in cuts this year and another 125bps next year.
Historically, whether equities rise or fall after rate cuts depends on if we enter recession or not
If the Fed’s rate cuts result in a soft landing, that’s historically been good for stocks (of course, past performance is no guarantee of future results). Research from Goldman Sachs shows that past rate cuts associated with soft landings (blue line) saw the S&P 500 gain about +15% in the year after the first cut.
But recessionary rate cuts (grey line) saw stocks fall 15% in the next year. (See more in today’s Markets Outlook.)
Of course, this makes sense. Rate cuts during a soft landing help stocks by reducing borrowing costs, which is good for earnings and valuations. And at the same time, those rate cuts should boost demand in an economy that’s already expanding.
During a recession, though, lower borrowing costs aren’t enough (at least initially) to offset a contracting economy, meaning demand falls, which hurts earnings and sales for corporates, pushing stock prices lower.
Too soon to say we’ll get a soft landing, but economy looks ok for now
Right now, it’s too soon to say if the Fed will achieve its soft landing goal. Even after this 50bps cut, rates are still 200bps above the estimated neutral rate, so they’re still a drag on the economy.
But at the moment, the economy is holding up reasonably well. We’ve got (relatively) low inflation, (relatively) low unemployment, and solid GDP growth. The Fed just needs to keep it that way.
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