The Fed’s 50 Basis Point Cut
This week, the Federal Reserve made waves with a (somewhat) surprising 50 basis point (bps) rate cut. Many economists expected a more modest 25 bps move. However, the market was pricing a two-thirds chance of the more sizeable reduction. Given the rather bold decision, the move can easily be interpreted with either optimism or pessimism. And that was evident in how the market reacted as well, with sizeable oscillations in both directions since the decision. Now that the Fed has begun its rate cut cycle, let’s look at all sides of the discussion.
The Glass is Half Full
From an optimistic perspective, Powell clearly emphasized that the labor market remains strong, with unemployment still at low levels despite an uptick in projections. And inflation, once the only focus, has moderated significantly. In fact, PCE inflation is now expected to be at 2.3% by the end of the year (down from 2.6% expected in June). The Fed is confident that its aggressive stance in previous months has effectively controlled inflation.
As Powell said, “Our restrictive monetary policy has helped restore the balance between aggregate supply and demand, easing inflationary pressures and ensuring that inflation expectations remain well anchored.”
The combination of steady growth and falling inflation suggests the economy can avoid a “hard landing,” where aggressive policy tightening could have caused a recession. Instead, investors can find comfort in the Fed’s willingness to recalibrate policy as needed, as evidenced by the expected end-of-year Federal funds rate of 4.4% compared to 5.1% just three months ago.
The Glass is Half Empty
However, some see a more cautious picture. The fact that the Fed is cutting rates even as GDP projections remain above the long-term trend could signal growing concerns about future economic conditions. The rise in unemployment forecasts also reflects potential vulnerabilities in the labor market. Powell did acknowledge, “As inflation has declined and the labor market has cooled, the upside risks to inflation have diminished, and the downside risks to employment have increased.”
Notably, the expected unemployment rate forecast was raised by 0.4 percentage points from June, with higher estimates continuing through 2026. However, Powell did try to downplay these concerns, explaining that while unemployment may tick upward, it’s not yet at alarming levels.
Moreover, Powell clarified that this 50 bps cut is not the start of a rapid series of cuts. “I do not think that anyone should look [at this 50 bps cut] and say this is the new pace,” he remarked. The concern is whether the Fed will remain too slow to adjust in the event of further economic softening. Waiting too long for more cuts could very well exacerbate any challenges ahead.
Volatile Market Response
Markets have certainly noticed the uncertainty. Stocks surged nearly 1% immediately following the rate cut announcement, but this initial excitement quickly faded as investors grappled with what this move truly means for the future. By market close, stocks were down about a quarter of a percent, while bonds and commodities experienced similarly dramatic fluctuations.
Subsequently, equities have bounced up and down in volatile trading sessions throughout the rest of the week, with rates and commodities similarly oscillating. So what caused the renewed volatility? It was likely Powell’s comment that “We are not on any preset course. We will continue to make our decisions meeting by meeting.”
Powell’s insistence that future cuts are not guaranteed leaves investors in a wait-and-see mode, which can fuel uncertainty. Until a more precise signal on the economic direction is given, market volatility may persist as the Fed navigates these uncertain waters.
Strong Economy or More Cuts?
What should investors and consumers take from this? First, don’t expect smooth sailing in the short term. Volatility will likely persist as the market digests this move and tries to predict what the Fed might do next. However, the Fed’s cautious optimism about economic growth and labor market resilience offers hope that this is part of a measured strategy to steer the economy through the uncertainty.
One thing is clear: we are at the beginning of an easing cycle. While the Fed shifts focus to maintaining employment while cautiously cutting rates, the key focus will be on underlying economic strength and whether the economy can grow enough to hold a steady jobs market without reigniting inflation.
Economy
- The Fed rate cut continued the recent volatility, but markets were higher on the week. The S&P was up 1.4%, the Nasdaq was up 1.5%, and the small-cap Russell 2000 was up 2.1%.
- Retail sales in the U.S. edged up 0.1% MoM in August, following an upwardly revised 1.1% surge in July, beating forecasts of a 0.2% decline, signaling consumer spending remains relatively strong.
- The number of people claiming unemployment benefits in the U.S. dropped by 12K from the previous week to 219K on the period ending September 14, reaching a new 4-month low.
Stocks
- U.S. equities were in positive territory. Energy and Financials were the top performers, while Real Estate and Consumer Staples lagged. Growth stocks led value stocks, and small caps beat large caps.
- International equities closed higher for the week. Emerging markets fared better than developed markets.
Bonds
- The 10-year Treasury bond yield increased 8 basis points to 3.73% during the week.
- Global bond markets were in negative territory this week.
- High-yield bonds led for the week, followed by corporate bonds and government bonds.
