Key takeaways from the Fed’s third rate cut

Washington
CNN
—

The Federal Reserve cut interest rates by a quarter point on Wednesday, the third rate cut since it began cutting borrowing costs in September.

The central bank’s latest move leaves its key interest rate at 4.25% to 4.5%, a two-year low.

The decision to cut was not unanimous, but is an attempt to ease the pressure on the American economy from increased interest rates in order to maintain the health of the labor market.

Federal Reserve Chairman Jerome Powell said the latest rate cut was “a closer step,” adding that recent inflation readings were “the single biggest factor” on officials’ minds during the meeting. Cleveland Fed President Beth Hammack was the only one to disagree with Wednesday’s decision, preferring to keep interest rates at their current levels.

The Fed signaled in its policy statement that it is inclined to keep interest rates stable going forward as inflation remains stubbornly above the central bank’s 2 percent target. The U.S. economy has also proven remarkably resilient in the face of increased borrowing costs, giving the Fed confidence that it can withstand without risking undue economic damage.

According to their latest forecasts, Fed officials planned just two rate cuts next year, compared to the four they had forecast in September. Officials also forecast slightly stronger economic growth, slightly lower unemployment and higher inflation in 2025 than previously thought.

Overall, the forecasts suggest Fed officials expect the U.S. economy to be buoyant next year with no recession in sight. They assume that inflation will reach its target over a longer period of time than previously assumed and will not reach the 2% mark until 2027.

Powell praised the U.S. economy in his post-meeting news conference, saying its strength had been “the story” of the year. Powell reiterated the likelihood of fewer rate cuts next year than forecasts showed.

That sent markets into a tailspin and the Dow fell more than 1,000 points.

Some investors are optimistic about the prospects for strong growth next year that could result from President-elect Donald Trump’s policies. The new administration is promising to extend 2017 tax cuts and tighten regulations, measures that will boost growth if implemented.

However, Trump’s threat of massive tariffs on goods from Mexico, Canada and China could derail the Fed’s current Goldilocks economics, as the tough tariffs Trump has imposed are widely expected to stoke inflation.

A former Fed president told CNN that the US economy has already achieved the exceptionally rare feat of a “soft landing” – a scenario in which inflation is tamed without a recession – and now it’s just a matter of maintaining it .

Here are the key takeaways from the Fed’s third straight rate cut.

According to estimates from the Fed and other economists, the U.S. economy is expected to remain solid next year.

Trump has indeed launched plans that could transform the economy, such as high tariffs and mass deportations, but it will generally take time for these plans, if enacted, to have an impact on the overall economy.

But for now, the Fed expects a robust US economy and persistent price pressure in 2025.

“I think the slower pace of cuts next year actually reflects both the higher rate of inflation this year and expected inflation,” Powell said.

The Fed chief said some officials have already started incorporating possible changes in trade policy into their economic models. Officials regularly develop simulations to understand what the economy might look like in the future.

In September 2018, when the first Trump administration went on a tariff spree, slapping tariffs on foreign goods from solar panels to washing machines, a Fed simulation thought it appropriate to raise interest rates if foreign countries imposed retaliatory tariffs and Americans followed suit expect inflation This is according to a declassified document from the Fed from 2018 that details policy alternatives and is known as the “Teelbook”.

Powell continued to express that there are still many uncertainties about Trump’s tariff plans, such as which goods will be subject to tariffs and how long any tariffs will be in place, saying that this is “not a question that concerns us right now.”

He did not rule out a rate increase in 2025.

Powell on US economic growth and the labor market

U.S. economic growth has been healthy this year, thanks to American shoppers continuing to open their wallets. Consumer spending, which accounts for about two-thirds of the U.S. economy, was boosted by a robust labor market with historically low unemployment.
According to the Department of Commerce, companies continued to invest in their operations throughout the year.

Powell said continued strength was one of the main reasons long-term interest rates, tied to the benchmark 10-year U.S. Treasury yield, have trended upward since the Fed’s first rate cut in September. This also includes mortgage interest.

“Most forecasters have been expecting a slowdown in growth for a long time, so we’re now in for another year of growth” that looks strong, he said. “The U.S. economy is just doing very, very well.”

Powell had a measured tone as he described the job market, noting that it was “still cool in many ways” but “not cooling down quickly or cooling down in a way that’s really breaking.” He said the labor market is not a source of inflationary pressure, adding that the Fed does not intend to further weaken activity, which could lead to either higher unemployment or a slower monthly labor market.

“This is a good job market and we want to keep it that way,” Powell said.

Overall, the American economy remains in good shape, but high inflation is not yet in the rearview mirror. The latest inflation readings reflect ongoing housing price pressures and a rise in the prices of food and some goods.

In summary, the economic data suggests that the Fed will keep interest rates stable until the downward trend in inflation gets back on track. Officials’ latest forecasts show inflation won’t reach the Fed’s target until 2027, a year later than estimated in September.