The Federal Reserve cut the short-term federal funds rate on Wednesday from 5.25–5.50% to 4.75–5.00%. This is the first rate cut since the Fed began to raise rates in March of 2022 coming out of Covid. It has long been expected that the Fed would cut at today’s meeting. The Fed has hinted at their last few meetings that they wanted to cut rates and that their focus has turned from curbing inflation to preventing downturns in the labor market.
If you listened to Jay Powell’s talk at the end of July when they LEFT Fed fund unchanged, he gave the impression that there was some difference of opinion on cutting or staying the course on rates. We would look at this as the 25 basis points that they were prepared to do then plus 25 basis points as maybe “insurance” or “booster shot,” as we have seen some weaker job numbers since the last Fed meeting.
Below is a chart showing the trailing 12-month CPI, the 10-year US Treasury yield, and the federal funds rate. There is no question that the bond market since last April has been anticipating this cut. And when you look at the federal funds rate versus the trailing inflation rate, these rates have started to bite and have shown their effects not only in the labor statistics but also in various Federal Reserve manufacturing indices.
The other way we know that the Fed has now done an about-face on their policy objectives is to look at the spread between the 2-year Treasury bond and 10-year Treasury bond. You can see that the curve starts to invert as we go into the Fed hiking cycle in March of 2022 when the federal funds rate was 0.0–0.25% (does that seem like a long time ago!). This curve has been disinverting and is now slightly positive after 2 ½ years of negative. The disinversion usually signals that the Fed is now in a cycle of cutting rates, and the yield spread was clearly signaling what we witnessed today – along with the nominal drop in the 10-year-bond yield in the past 2 months.
FOMC participants signaled that more cuts are ahead with another 25 or 50 basis points before year-end. Does this mean a soft landing for the economy? We will find out, but today the Fed clearly took a step in trying to assure that outcome.
John R. Mousseau, CFA
Chief Executive Officer & Director of Fixed Income
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