On Wednesday, the Federal Reserve reduced its benchmark interest rate by a quarter percentage point for the second time this year, adjusting short-term borrowing rates to a range of 3.75% to 4%.
The Fed noted, “Available indicators suggest that economic activity is expanding at a moderate pace. Employment growth has slowed this year and the unemployment rate has ticked up slightly but remains low through August. Recent indicators reflect these trends. Inflation has risen since the start of the year and is still moderately high.” This statement came following a two-day policy meeting.
The rate cut aims to bolster the labor market amid several months of dwindling job growth. Investors largely anticipated the decision, especially given that an ongoing government shutdown has delayed major economic reports, leaving policymakers without timely data on employment and inflation trends.
This latest reduction brings the federal funds rate to its lowest point in three years, following a similar cut in September. Additionally, the central bank decided to pause the reduction of Treasury securities from its $6.6 trillion balance sheet.
Fed officials are grappling with uncertainty around further rate cuts as they navigate various risks. Some say inflation, hovering around 3%, is still too elevated to warrant additional cuts, while others argue that it signifies the economy losing steam and requiring more support.
“When you’re driving in fog, you slow down,” Powell remarked in a press conference after the meeting.
Chairman Powell maintained that inflation, excluding tariffs, is nearing the Fed’s 2% target. He mentioned that while tariffs are driving prices up, these effects are likely short-lived, and he expects inflation to realign with the target once tariff-related costs are fully accounted for.
The unavailability of official data has intensified these differing opinions. Without key indicators on employment, spending, and prices, officials have turned to limited private research and previous patterns to gauge the economy’s direction.
“There were very different views today, but the takeaway is that we haven’t made a decision for December yet. We will review the data we have and consider its impact on our outlook and risks,” Powell noted. Investors are now looking forward to the December meeting, when policymakers will decide whether to continue easing rates or pause to evaluate the effects of recent cuts. The decision may depend on whether government data becomes available in time for a clearer assessment of economic health.
The Fed’s decision wasn’t unanimous. Kansas City Fed President Jeffrey Schmidt and Fed President Stephen Milan voted against the rate cut, with Milan expressing a preference for a more significant cut of 0.5 points. This marks the third consecutive meeting where the Fed has experienced a split on decisions regarding benchmark interest rates, with 10 other members supporting the quarter-point reduction.
The federal funds rate is the interest rate at which banks lend to each other overnight on their reserve balances. These reserves are deposits held at the Federal Reserve for settling payments. At present, U.S. banks are not the main borrowers in this market, partly due to the Fed operating in a “reserve-rich” environment, where most financial institutions hold surplus reserves. Instead, U.S. branches of foreign banks tend to be the primary borrowers, often having small domestic deposit bases. Reserve requirements for U.S. banks were lifted in March 2020.
The Fed pays interest on reserves, and in light of Wednesday’s interest rate cut, the interest rate on reserve balances has been adjusted to 3.90%. This rate has become an important tool for influencing short-term funding costs and, in turn, borrowing rates across the economy.
