First Fed cut is a slash

There was never any question the Federal Reserve was poised to cut the fed funds rate today from the 5.25-5.50% range that had held since July of 2023. The only question was by how much. Going into the decision by the Federal Open Market Committee (FOMC), the market had priced in a 35% chance of a 25 basis-point cut and a 65% chance of a twice that, guaranteeing that some portion of investors would be surprised by the outcome.

So what happened? The Fed opted for the bigger swing, slashing the target range by a half-percentage-point from a midpoint of 5.375% to 4.875%. The dovish tack appeared in the Summary of Economic Projections (SEP). Its “dot plot,” the projection of where members think the rate is heading, fell to 4.375% from 5.1% for year-end 2024. Similarly, its forecast for the year-end 2025 rate fell to 3.375% from 4.1%. However, the long-run Fed Funds rate continued to edge higher, shifting to 2.9%. This is an important statistic for the market because it is assumed to be the Fed’s best guess at the “neutral” fed funds rate, or the level at which both inflation and the unemployment rate are low and stable.

By cutting by 50 instead of 25 basis points, the Fed is signaling they are confident inflation is on a sustainable path to 2%. FOMC members lowered their projection for core PCE inflation to 2.2% from 2.3%. But the larger move would seem to show they are determined to nail a soft landing by preventing a slowing labor market from dragging the economy into recession. “The labor market is in a solid condition, and we want to keep it there; same for economy,” Fed Chair Jerome Powell said in his post-meeting press conference. The argument can be made that front-loading cuts increases chances of economy remaining strong.

While the decision drew the first dissent since 2005, with Governor Michelle Bowman preferring a quarter-point reduction, Powell downplayed that, pointing to the fact that all members expected multiple cuts this year—specifically a quarter-point cut in each of the two remaining meetings. “There is a lot of common ground,” he said. The yield curve slightly steepened as the larger reduction validates the low level of short-term Treasury yields in recent weeks.

The reduction of the Fed’s balance sheet continues. As this somewhat counteracts the impact of rate cuts designed to loosen monetary policy, we expect that to slow and eventually stop later this year.