WASHINGTON – The U.S. Federal Reserve on Wednesday cut its key interest rate by a quarter of a percentage point. This was the third consecutive reduction, and there was a sense of caution about further reductions in the coming years.
In a move widely expected by markets, the Federal Open Market Committee lowered the overnight borrowing rate to its target range of 4.25% to 4.5%, returning it to its December 2022 level, when rates were rising.
There was little intrigue in this decision itself, but the main problem is that inflation remains steadily above target and economic growth is fairly strong, conditions that do not normally equate to policy easing. The question was what the Fed would signal about its future intentions.
Read what’s changed in the Fed statement.
In cutting interest rates by 25 basis points, the Fed suggested that there would probably only be two more rate cuts in 2025, according to a dot-plot matrix that closely monitored each member’s future rate expectations. The two cuts marked the commission’s intention to split in half when the plot was last updated in September.
Assuming quarterly point increments, officials suggested two more cuts in 2026 and another in 2027. In the longer term, the Committee sees a “neutral” fund rate of 3%, 0.1 percentage point higher than in the September update, as levels have been gradually changing. This year it’s higher.
“Today’s action lowers the policy rate by 1 percentage point from its peak and significantly eases the policy stance,” Chairman Powell said at a post-meeting press conference. “Therefore, we may be more cautious when considering further adjustments to policy rates.”
“It was a close call today, but we decided it was the right one,” he added.
Stocks sold off and Treasury yields rose following the Fed’s announcement. Futures prices have cut expectations for a rate cut in 2025 by a quarter of a percentage point, according to CME Group FedWatch indicators.
“We’ve moved pretty quickly to get to this point, but I think we’re definitely going to move slower going forward,” Powell said.
For the second consecutive meeting, Cleveland Fed President Beth Hammack wanted the Fed to maintain its previous interest rates, leading to one FOMC member’s dissent. Gov. Michelle Bowman voted against it in November, marking the first time a governor has voted against a rate decision since 2005.
The federal funds rate sets the amount banks charge each other for overnight loans, but it also affects a variety of consumer debts, such as auto loans, credit cards, and mortgages.
The post-meeting statement was largely unchanged except for adjustments to the “scope and timing” of further interest rate changes, with some wording changed from the November meeting. Goldman Sachs said the latest adjustment “suggests a slower pace of rate cuts going forward.”
Changes in the economic outlook
The cuts came despite the committee raising its forecast for gross domestic product (GDP) growth for all of 2024 to 2.5%, 0.5 percentage points higher than in September. However, officials expect GDP to slow to the long-term forecast of 1.8% over the next few years.
In other changes to the economic forecast summary, the committee lowers the expected unemployment rate this year to 4.2%, while raising the Fed’s preferred headline and core inflation estimates to 2.4% and 2.8%, respectively. was slightly higher than expected. This is above the September forecast and the Fed’s 2% target.
The committee’s decision comes not only because inflation remains above the central bank’s target, but also because the Atlanta Fed has forecast economic growth of 3.2% in the fourth quarter and the unemployment rate is near 4%. The decision was made in the midst of the current situation.
This situation is most consistent with the Fed raising or keeping rates unchanged, but officials are wary of the risk of keeping rates too high and unnecessarily slowing the economy. Despite macro indicators to the contrary, the Fed’s report earlier this month said economic growth had only increased “slightly” in recent weeks, with signs of falling inflation and slowing employment.
Additionally, the Fed will have to deal with the effects of fiscal policy under President-elect Donald Trump, who has announced plans for tariffs, tax cuts, and mass deportations, all of which will drive inflation and complicate the central bank’s job. There is a possibility that
“We need to take our time and carefully evaluate President Trump’s plan, but only after we see what the policy is and how it is being implemented,” Powell said. said. “We’re not at that stage yet.”
Normalization policy
Chairman Powell suggested that the rate cut was an effort to recalibrate policy because it doesn’t need to be as restrictive under the current circumstances.
“We think the economy is in a very good place. We think the policy is in a very good place,” he said Wednesday.
Wednesday’s action marks the Fed’s first full cut in its benchmark interest rate since September, when it took the unusual step of cutting it by half a percentage point. The Fed generally prefers to move up and down in smaller quarter-point increments when considering the impact of its actions.
Despite aggressive price cuts, the market is taking the opposite stance.
Both mortgage rates and Treasury yields rose significantly during this period, perhaps indicating that the market does not believe the Fed can cut rates significantly. The yield on the policy-sensitive two-year U.S. Treasury rose to 4.3%, above the range of the Fed rate.
In a related action, the Fed adjusted the interest rate paid under the overnight repo facility to the floor of the federal funds rate. The so-called ON RPP rate is used as a lower bound for the fund interest rate, which was trending towards the lower end of the target range.
