What is the context?
The rate cuts come amid some interesting macroeconomic situations.
On one hand, we are seeing stabilizing inflation.
But this is leading to a cooling phase in the labor market. On top of all, global economic uncertainties are growing. More on it later!
This decision follows a period of aggressive rate hikes that began in 2022 to curb post-pandemic inflation.
The Journey from Near-Zero Rates to Aggressive Tightening
March 2020: Fed slashed rates to near-zero to support the U.S. economy during the COVID-19 pandemic.
2022-2023: In response to inflation (driven by supply chain issues and global conflicts), the Fed raised rates to 5.25%-5.50%, a two-decade high.
Present Day: As inflation eases and job growth slows, the Fed is now shifting towards easing monetary policy.
Why Cut Rates Now?
Several factors have contributed to the Fed's readiness to shift gears and begin cutting rates:
Easing Inflation: Inflation is nearing the Fed’s 2% target, reducing the urgency for higher rates.
Cooling Labor Market: Job growth has slowed, with 142,000 jobs added in August compared to 202,000 in the previous year’s monthly average.
Global Economic Conditions: Slowing global growth and stabilized financial markets give the Fed a window to lower rates.
Predictions for the Rate Cut
The Federal Open Market Committee (FOMC) will meet on September 17-18 to finalize its decision on the rate cut, and the magnitude of the reduction is a hot topic. What can happen realistically? Let’s explore all options.
25 Basis Points (bps) Cut: Investors SAD
This is expected by most analysts, including those at Bank of America.
It is a safe, gradual approach that offers flexibility for future cuts. A smaller 25 bps cut now, followed by incremental cuts, would give the Fed more control and time to assess the impact.
Based on updated economic data, another 25 bps cut could follow in November.
50 Basis Points (bps) Cut: Investors HAPPY
Supported by some policymakers who believe more aggressive cuts may be needed to support the labor market.
Larger, faster cuts could provide immediate economic relief but may pose risks of higher inflation.
Is it a Balancing Act Before the 2024 Presidential Election
Source: ft.com
We all know the elections are here. US elections indirectly determine the global economic policies, at least for the next few years.
The cut comes just two months before the 2024 U.S. presidential election. While the Fed insists its decisions are based solely on economic data, the timing could be seen as politically sensitive.
Here is the catch. The decision WILL have an impact on voters.
Lower rates can reduce borrowing costs for consumers and businesses. Voters borrow more, spend more, voters ‘happy’!
Further Implications for the Economy and Financial Markets
The Fed’s decision to cut rates will have widespread implications for various sectors of the economy:
Borrowing Costs: Lower interest rates will reduce the cost of borrowing for mortgages, personal loans, and business expansion.
Equity Markets: Lower rates could boost stock prices by reducing the discount rate for future earnings.
Bond Markets: Long-term bond yields may rise if inflation expectations increase as a result of rate cuts.
U.S. Dollar: A weaker U.S. dollar is likely as rates decrease, which may make U.S. exports more competitive globally.
What’s Next?
September 17-18 FOMC Meeting
Fed officials will debate whether to cut rates by 25 or 50 bps. The decision will unapologetically set the tone for future cuts.
The rate cuts signal the beginning of a new monetary policy phase, expected to continue through 2025. The goal is to balance economic growth with inflation control. Is it going to go as planned? Nobody knows.
Investors should be focused on reacting to rate cuts rather than try to predict and outsmart the Feds.
For long-term investors this is a piece of cake. Fed cuts rate, you invest more for the next quarter.
For wannabe investors: watch now. The market will be volatile. There are NO good entries.
For short-term investors and traders, build your position after the response of the banks. Do they cut rates too? Are they happy to pump the inflation? If yes, get in and do the dirty work.
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