Federal Reserve chair Jay Powell sent his clearest signal yet on Wednesday that the US central bank was done with two years of tightening monetary policy and would begin cutting rates in 2024, sending Wall Street’s benchmark index closer to a record high as investors celebrated the prospects of lower borrowing costs.
The Fed held interest rates at a 22-year high, but the decision came alongside new forecasts from central bank officials pointing to 75 basis points worth of cuts next year — a more dovish outlook for rates than in previous projections.
Powell’s comments after the Fed’s decision also pointed to a switch in tone from the bank. The benchmark rate was now “likely at or near its peak for this tightening cycle”, he said.
The decision by the Federal Open Market Committee to hold rates at 5.25 per cent to 5.5 per cent came alongside publication of the Fed’s so-called dot plot, which showed that most officials expected rates would end next year at 4.5 per cent to 4.75 per cent.
Officials expect rates to fall even lower in 2025, with most officials forecasting they would end up between 3.5 per cent and 3.75 per cent.
Those projections for a steeper pace of rate cuts triggered a rally in US stocks and a sharp fall in Treasury yields, with the two-year yield recording its biggest daily decline since the collapse of Silicon Valley Bank in March.
The two-year Treasury yield, which moves with interest rate expectations, fell 0.3 percentage points to 4.43 per cent after the Fed’s announcement. The benchmark 10-year Treasury yield fell 0.17 percentage points on Wednesday, and dropped further during Asia morning trading to sit below 4 per cent for the first time since August.
The benchmark S&P 500 gained 1.4 per cent to close at its highest level since January 2022.
“They went from higher for longer in September to talking about rate cuts,” said Priya Misra, a portfolio manager at JPMorgan Asset Management. “They were behind the curve on inflation, but maybe they want to be ahead of the curve in terms of a slowdown.”
In a statement, the Fed spelt out the conditions under which it would consider “any additional policy firming that may be appropriate to return inflation to 2 per cent over time” — softer language that suggests the central bank may not see a further need to raise rates again.
Powell reiterated that the central bank was committed to proceeding “carefully” with future rate decisions given expectations that economic growth would cool and there had been “real progress” on beating back inflation.
He drove home that point, saying the Fed did not want to restrict the economy longer than necessary.
“We’re aware of the risk that we would hang on too long,” Powell said, referring to waiting too long to cut rates. “We know that’s a risk and we’re very focused on not making that mistake.”
He later added the Fed would not wait until inflation had returned to 2 per cent to begin to cut rates because “you’d want to be reducing restriction on the economy well before” that point “so you don’t overshoot”.
The latest decision comes as the Fed tries to keep monetary policy tight enough to drive inflation back down to its 2 per cent target without damaging the economy and causing too many job losses.
Traders thought the Fed would start reducing borrowing costs in March, but after this week’s inflation data and a strong jobs report on Friday, they are betting that the cuts will start in May.Leading up to Wednesday’s rate announcement, traders had wagered interest rates could fall more than a percentage point next year.
Projections from Fed officials for unemployment were barely changed from September, with officials still expecting only a slight uptick in the jobless rate to 4.1 per cent in 2024, from 3.7 per cent now.
However, estimates for core inflation, as measured by the personal consumption expenditures index, were lowered slightly, with officials expecting it to hit 2.4 per cent in 2024 and 2.2 per cent in 2025. In September, median projections showed inflation hitting 2.6 per cent in 2024 and 2.3 per cent the following year.
To consider rate reductions, the Fed needs to be confident that inflation is trending back to 2 per cent in a sustainable way. If slower consumer price growth is accompanied by a sharp rise in unemployment, the rationale to cut would be clear.
The looming question is what happens if the economy holds up as inflation falls. Officials like John Williams, the president of the New York Fed, and Christopher Waller, a Fed governor, believe that it may still be necessary to ease monetary policy. This is to ensure that interest rates, when adjusted for inflation, do not become too burdensome for households and businesses.