By Brian Johnson, Director of Investment Services

Well, the wait is finally over. After months of speculation, the Federal Reserve Open Market Committee (FOMC) officially took action at their meeting on September 18, cutting the benchmark fed funds rate by 50-basis points (0.50%) to a target rate of 4.75-5.00%. There was some speculation we could see a smaller, 25-basis point cut, but the 50-basis point cut appears to be indicative of the Fed trying to thread the needle of not stifling demand in the economy and keeping the lid on inflation.

It’s worth noting that a 25-basis point cut would have been more in line with the FOMC’s historic practice when entering a rate cutting cycle. The last time the FOMC cut their target rate by 50-basis points was in March of 2020 (at the start of the COVID-19 pandemic). Before that, the last 50-basis point cut took place in September of 2007 amid the U.S. housing crisis. The decision to cut by 50-basis points indicates recognition by policy makers that a persistently inverted yield curve typically comes at the expense of long-term growth in the economy.

The market and economists are speculating this rate cut is just the beginning of a series of future rate cuts by the Federal Reserve (Fed). The Fed prefers to see how changes to the policy rate impact the broader economy, which typically comes with a lag, in advance of future meetings, but the anticipation is that a series of rate cuts will provide relief to consumers and small business grappling with elevated financing costs.

CME’s FedWatch Tool is currently pricing in a 91% chance of a 25-basis point cut at the Fed’s next meeting in November and a 71% chance of another 25-basis point cut at their meeting in December. If these future cuts come to fruition, we could be looking at a federal funds rate that is a full 1.00% lower than where we started the year.  It’s fair to state that as recently as twelve months ago the “market” anticipated a much more aggressive rate-cutting cycle over the course of this calendar year.

Economic data over the past several months has shown a steady decline in inflation. The year-over-year Consumer Price Index (CPI) reading rose by 2.4% in September while the Fed’s preferred measure of inflation, the Personal Consumption Expenditures (PCE) index, rose by 2.2% in August. While we’re not at the Fed’s preferred inflation target of 2% just yet, inflationary pressures have eased considerably from the 9.1% high that we saw in June of 2022.

The Fed has a dual mandate – price stability and maintaining maximum employment. While easing inflation has been beneficial to price stability, it appears the Fed has now shifted its focus to the labor market. The September employment report came in red hot, showing the economy adding over 250,000 jobs during the month. That number was far above economists estimates of 150,000 jobs. The U.S. unemployment rate through September fell to 4.1%.  While recent economic data shows the economy’s resiliency, in order to achieve a “soft landing,” the Fed will need to balance how aggressive it will be with future rate cut decisions to keep inflationary pressures low, while also maintaining broad wage and job growth.

Following the FOMC’s meeting on September 18^th, Chair Powell reiterated the Fed’s stance in his post meeting press conference by stating that, “We’re trying to achieve a situation where we restore price stability without the kind of painful increase in unemployment that has sometimes come with disinflation.” Powell continued to add that the FOMC’s 50-basis point rate cut is showing a “strong commitment” toward achieving that goal.

Moving forward, upcoming data releases will be particularly informative for future rate decisions as the FOMC only meets two more times in 2024, on November 7^th and December 18^th. If the economy continues to show resiliency, that data supports the expectation that the Fed will continue to gradually cut rates.

While future rate decisions remain to be seen, we continue to stress the benefit of building diversified investment portfolios that can weather various interest rate cycles. Interest rates go up and interest rates go down, but the most important thing is to have a plan in place to weather those market fluctuations. As yields in short-term products such as money market funds and Local Government Investment Pools (LGIPs) start to fall as a result of the FOMC’s actions, targeting a long-term investment strategy is a great way to build cash flow stability for your entity’s operating needs.

If you’re interested in discussing different portfolio strategies, please contact your Ehlers Investment Adviser to learn more.

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