Federal Reserve’s first rate cut since 2020 signals policy shift amid sluggish economic growth and inflation targeting
The timely and decisive action of the Federal Reserve in changing the federal funds rate to a lower range of 4.75% to 5% on September 18, 2024 should be noted that it was cut down by 50 basis points. This rate cut was the first since March 2020 and signalled a change in policy having kept the rate pegged at a historical 23 year high for too long. This shift in policy comes when the level of economic activity is growing slowly and the rate of inflation which the Federal Reserve is aiming at is capturing 2%.
Justification for the Federal Reserve Rate Cut
By undertaking such a decision the Federal Reserve adheres to the purpose as dictated by the two-fold expectations of maximum employment and price stability. With regards to issues that have engaged most of the over the past year, it was to do with inflation. Recent information has been indicating reduction in inflationary confinement. This is where the Fed has been able to shift its focus to making the economy grow and employ more people without putting its head way down in as far as inflation control is concerned.
“With respect to the economy, the rate cut is meant as a boon to further ensure strength of what Mr. Powell has called a robust labor market. The decision is meant to be defensive to fight the potential risk before even the risk arrives. Therein lies the balanced conundrum. Overly aggressive rate cuts may stoke the flames of inflation which are sought to be extinguished. On the other hand, sustained elevated rates may stifle economic activity altogether.”
Market Response
Investors welcomed the announcement of the Fed; therefore, the financial market performed well. The S&P 500 index hit its all-time high and gains were recorded in the stock indices of the Nasdaq Composite and Dow Jones Industrial Average. Treasury rates experienced ups and downs primarily captured by the 2-year note, which is rate sensitive, but on the whole these rates went up as well, given the circumstances.
Commenting on Fed decision Dhawal Ghanshyam Dhanani, Fund Manager, SAMCO Mutual Fund said
“A very bold surprise move by the Fed who cut rates aggressively by 50 bps contrary to expectation of a 25 bps cut. This certainly marks the beginning of a pivot in interest rates after more than four years, though the final impact on the markets will be dictated by other economic data such as labour rates, inflation, unemployment rate etc that still needs to be keenly observed. The US isn’t the first economy to have cut rates, the UK, Eurozone and Canada have already begun this cycle while India is on a wait and watch mode. History shows that more often than not India has followed the US in any interest rate pivot and this time too there is high probability that we will follow suit”.
They are somewhat proceeding with caution, because this latest action by the Federal Reserve means that they wish to foster growth without overheating the economy in other to cause a recession. In the past, whenever these large cuts in interest rates were imposed, there was always a prevailing crisis- this time though, there is strength in households and companies’ balance sheets.
Economic Implications
This rate cut is likely to have several effects on the USA economy, which includes:
Consumer and Business Spending: Since interest rates will go down, borrowing will be cheaper and therefore consumers and businesses can do more spending. Such increase of demand can help to maintain growth with special emphasis on those sectors which are considered to be interest rate sensitive, for instance construction and other things like temperate goods.
Financial Markets: A lower interest rate environment often benefits stock markets, as cheaper borrowing can lead to higher corporate earnings. However, bond market volatility may persist as investors adjust to the new rate trajectory.
Inflation Risks: Despite the Federal Reserve’s assertion that inflation is under control, there remains a risk that cutting rates too much, too quickly could rekindle price pressures. The Fed will closely monitor incoming data to fine-tune future policy actions .
Global Economic Impact: The Federal Reserve’s move has international implications. A lower federal funds rate can weaken the U.S. dollar, making American exports more competitive and potentially supporting the global economy amid geopolitical tensions and slowing growth.
The Federal Reserve has indicated that further rate cuts are possible this year, contingent on economic conditions and the outlook for inflation and employment . The decision was not unanimous; one member of the Federal Open Market Committee preferred a smaller cut, highlighting concerns about the potential risks of excessive easing.
The Federal Reserve’s latest action underscores the challenges of navigating an economy that, while resilient, is showing signs of deceleration. As policymakers strive for a “soft landing,” they must carefully balance their approach to avoid triggering inflation while preventing an economic downturn. The coming months will reveal whether this bold rate cut was a strategic success or a potential miscalculation.
Ultimately, the Fed’s decision reflects not just an assessment of current conditions, but also a strategic shift to ensure sustainable economic growth amid rising uncertainties.
