Market Wire: Fed Cuts, Completes Transition Toward More Dovish Reaction Function

The Federal Reserve cut rates for the first time this year as policymakers opted to downplay inflation risks in favour of providing support to increasingly-beleaguered labour markets. In a well-telegraphed and fully-priced decision, the Federal Open Market Committee voted along less-divided 8-1 lines to lower the target range for the federal funds rate to between 4.00 to 4.25 percent. In a surprise, Trump appointee Stephen Miran was the single dissent from the majority, voting in favour of a bigger cut, while the remainder of the committee opted for the quarter point move.

In the statement setting out the decision, the rate-setting committee acknowledged signs of incipient economic softness, saying “job gains have slowed, and the unemployment rate has edged up but remains low. Inflation has moved up and remains elevated”, and pointed to a shift in the balance of risk, saying that it now “judges that downside risks to employment have risen”. This is a departure from all of the statements earlier this year, which used the word “solid” to characterise the labour market.

Although the statement language stopped short of signalling future moves, the all-important “dot plot” Summary of Economic Projections showed the median policymaker expecting to cut rates two more times before year end—one more than had previously been expected. This is, however, largely down to the newest addition to the committee, with a single dot suggesting that one official—likely Stephen Miran—expects to see five rate cuts by December*.

Median core inflation expectations remained steady, even as growth forecasts were raised slightly for this year and next.

The dollar is holding steady and Treasury yields are largely unchanged on the policy-sensitive front end of the curve, but equity markets are reacting positively as investors recalibrate positions ahead of the post-decision press conference. Chair Powell is expected to maintain the tone conveyed in late August’s comments at the Jackson Hole Economic Symposium, where he shifted the central bank’s focus away from fighting inflation and toward combatting a decline in underlying demand for workers.

The bottom line is that the Fed’s reaction function has shifted in a more dovish direction, meaning that a continued deceleration in the economy will lead to further easing—even if inflation remains too hot for comfort. But the jury remains out on whether a slowdown in growth is truly occurring, and we are bracing for more volatility in the months ahead as prevailing market narratives switch direction.

*I can’t confirm whether there was a kid’s table set up for him.