Market Wire: Fed Delivers Dovish Half-Point Rate Cut

The Federal Reserve cut its benchmark borrowing rate by half a percentage point this afternoon, and paired its decision with an updated rate outlook that points to more easing ahead.

Eleven of twelve members voted for the action, with Governor Bowman - a known hawk - favouring a quarter-point move. In the statement setting out the decision, officials said “The Committee has gained greater confidence that inflation is moving sustainably toward 2 percent, and judges that the risks to achieving its employment and inflation goals are roughly in balance,” noting that they remain “strongly committed to supporting maximum employment” and staying attentive to “both sides” of their dual mandate.

According to the accompanying “dot plot” Statement of Economic Projections, the benchmark federal funds rate is expected to end 2024 at around 4.4 percent - a level that implies four 25-basis point reductions this year, well aligned with the number currently priced into swap curves - before falling to 3.4 percent in 2025. In the previous iteration, the median projection was for just one quarter-point cut by the end of this year.

The long-run projection for the Fed Funds rate climbed to 2.9 percent from 2.8 percent under the previous set of projections - suggesting that policymakers are gradually lifting “neutral rate” estimates as the economy demonstrates ongoing resilience.

Under the updated forecasts, the core personal consumption expenditure price index is seen rising 2.6 percent this year - down from 2.8 percent in June - and 2.2 percent in 2025, also below the 2.3 percent previously estimated. Unemployment is expected to rise to 4.4 percent by the end of 2024, well above the 4.0 percent estimated under the previous projection. Growth expectations were lowered slightly, with the economy seen expanding 2.0 percent this year - instead of 2.1 percent - before maintaining the same pace in 2025.

Initial price action in financial markets is consistent with a relatively-dovish interpretation of the Fed’s likely policy path, with equity markets climbing, Treasury yields tumbling, and the dollar retreating against its major counterparts.

But complex interactions between the language in the statement, the signalling embedded in the dot plot, and Chair Powell’s words in the post-decision press conference - combined with positioning-related factors and a heightened sensitivity to US policy changes among foreign central banks - could generate counter-intuitive reactions in currency markets in the minutes and hours ahead.

The dollar’s decline should gain momentum, but the scale of the rate cut could also spook retail investors into bracing for a steeper downturn, forcing risk-sensitive currencies lower. The decision might simply push US rates lower, but could also clear the way for an acceleration in easing from other major central banks, making the Bank of Canada more likely to deliver an equivalently-sized cut at its October meeting and increasing pressure on the European Central Bank and Bank of England to move more quickly.

We can’t rule out market reversals in the coming hours, and would urge hedgers to remain watchful, even if underlying trends appear favourable.

Note: to watch the post-decision press conference, see the Fed’s livestream here or Youtube channel here