The Federal Reserve cut interest rates by half a percentage point on Wednesday and is expected to cut them by another half a percentage point at its two remaining meetings this year, signaling a faster pace of monetary stimulus than analysts had expected over the summer.
The Fed now sees interbank lending rates falling to a midpoint of 4.4% by the end of this year, down from the 5.1% it projected in June.
The central bank now expects the economy to have a higher unemployment rate than it did in June, and sees the unemployment rate rising to 4.4% from 4.0% by 2024. After surging to 4.3% in July, the unemployment rate fell slightly to 4.2% in August.
Inflation forecasts were cut accordingly, with the Fed lowering its forecast for personal consumption expenditures price index growth to 2.3% from 2.6% annual growth in 2024. Inflation is projected to fall to 2.1% next year.
Federal Reserve Chairman Jerome Powell on Wednesday rejected claims that the central bank's big interest rate cuts, given the recent downward revision of jobs data, indicate the central bank is off track with inflation.
“We don't think we're behind,” he said. “We think this is timely, but I think it will be seen as a sign of our determination not to fall behind.”
Analysts expressed surprise on Wednesday at the size of the Fed's rate cut, saying it could signal fragility in the employment picture.
“This is a bit of a surprise. [basis point] “The cut signals an abrupt shift in focus to the maximum employment mandate and a sharp improvement in confidence in inflation developments over the past month and a half,” Brian Coulton, chief economist at Fitch Ratings, said in a commentary.
“This suggests the Fed is more concerned than most about the state of the labor market, where the pace of job creation still looks fairly strong (averaging 116,000 per month over the past three months),” he added.
Elizabeth Lenter, senior economist at NerdWallet, said the big rate cut suggests the Fed is aware of potential weakness in the labor data.
“Today's cut was larger than most expected, signaling the Fed is taking a cautious stance regarding the weakening labor market,” she said in a commentary. “The economy is slowing aggressively, and a small cut may have been overly cautious. By cutting rates by a half-percentage point now, Fed Chairman Powell and his colleagues are no doubt feeling confident about inflation developments and seeing some warning signs in the data.”
Other analysts said the Fed's sharp rate cuts were a sign it was trying to learn from past mistakes.
“The Fed was late in raising interest rates to tame inflation, but it appears the lesson has been learned,” Bankrate financial analyst Greg McBride said in an op-ed.
“The labor market remains strong,” Powell said Wednesday, but acknowledged that it is “not a source of rising inflationary pressures.”
Despite interest rates rising from 2022 to 2023 and inflation falling from a high of 9% in 2022 to 2.5% as of August, the unemployment rate remains low in absolute terms.
This low level has remained mainly because the number of job openings has fallen relative to the number of unemployed people, rather than because difficult investment conditions have led to widespread job losses.
But Powell warned Wednesday that the ratio of job openings to job seekers is now down about 1-to-1, and any further decline in job openings would be reflected more quickly as an increase in the unemployment rate, a scenario mentioned much in market commentary on Wednesday.
“We appear to be approaching that point, or maybe already at it, so any further declines in job openings would translate more directly to job losses,” Powell said, noting that immigration is also likely contributing to the job openings filling up so quickly. Earlier this year, the Congressional Budget Office measured 1.6 million more immigrants than the regular Census estimate.
Powell described the tightening employment situation as a “big downturn.”
“We've seen examples where that has led to significant labor market tightening without it leading to a decline in employment,” he added.
While interest rate cuts are already priced into the market, the new macroeconomic dynamic of lower interest rates that began on Wednesday is already influencing the political debate, with Democrats welcoming the economic stimulus that lower interest rates will bring.
“I applaud the Federal Reserve for making the necessary decision to cut interest rates by 50 basis points,” Rep. Maxine Waters of California, the top Democrat on the House Financial Services Committee, said in a statement. “Inflation is near pre-pandemic levels, supply chain strains have eased, employers are adding jobs, and Americans are spending money just as they did before the pandemic. Simply put, the economy is well on a stable path toward a full recovery.”
Sen. Richard Neal (R-Mass.), a Democrat on the Senate Ways and Means Committee, offered similarly complimentary comments about the state of the economy.
“We have lowered unemployment and kept global inflation at record lows. Today, monetary policy is shifting in the right direction to reflect that progress, and Americans will soon feel the relief of lower borrowing costs,” he wrote.
The Fed also slightly lowered its forecast for the economy's overall performance, lowering its forecast for real gross domestic product (GDP) change to 2% from a 2.1% forecast. Its GDP forecasts for 2025 and 2026 remained unchanged at 2% annual growth.
