Introduction
The Federal Reserve made a decisive move by cutting interest rates by 0.5% (50 basis points), a bold step that surpasses earlier expectations of a modest 0.25% reduction. This action marks the beginning of a rate-cutting cycle that reflects the Fed’s evolving view of the economic landscape. To shed light on this development, we’ll explore insights from leading economists Brian S. Wesbury and Robert Stein of First Trust Economics, and Jan Hatzius of Goldman Sachs, to understand the implications for the economy and future monetary policy.
First Trust Economics’ Perspective
Brian S. Wesbury, Chief Economist, and Robert Stein, Deputy Chief Economist
Wesbury and Stein point out that the Fed’s aggressive rate cut represents a significant shift from its previous stance. After the June meeting, Fed members projected only a single 25 basis point cut in 2024. The unexpected 50 basis point cut suggests that the Fed now perceives greater risks within the current economic conditions.
Key Takeaways from Their Analysis:
- Labor Market and Inflation Balance:
The Fed has adjusted its language around the labor market, signaling that it now views the risks between inflation and employment as more balanced. With increased confidence, the Fed believes inflation is gradually moving toward its 2% target, justifying today’s cut. - Revised Economic Projections:
The unemployment rate is now forecasted to reach 4.4% by the end of the year, an increase from the June projection of 4.0%. Meanwhile, Personal Consumption Expenditures (PCE) inflation expectations have been adjusted downward from 2.6% to 2.3%. This reflects a weakening labor market alongside a moderation in inflation. - More Rate Cuts Expected:
The Fed anticipates an additional 50 basis points of cuts before the end of the year, likely distributed as 25 basis point cuts during the remaining two meetings.
Wesbury and Stein warn that the Fed and markets might be overlooking critical indicators. They stress the importance of monitoring the money supply, specifically the M2 measure, which has been gradually increasing after a period of contraction. Should these rate cuts spur rapid M2 growth, inflation could re-accelerate, reminiscent of the 1970s inflationary spiral when premature easing led to long-term inflationary pressure. The balance between inflation and economic growth, therefore, hinges on how money supply evolves in the coming months.
Goldman Sachs’ Insights
Jan Hatzius, Chief Economist
Jan Hatzius of Goldman Sachs agrees that the 50 basis point cut was the right move, especially in light of favorable inflation data and the softening labor market. However, he highlights that not all Fed participants were in favor of the larger cut, signaling a divergence of opinion within the Federal Open Market Committee (FOMC).
Highlights from His Analysis:
- Shift in Focus to Employment Risks:
The Fed’s decision marks a shift from prioritizing inflation risks to now addressing potential issues in the labor market. This change is driven by the recent softening of job growth data in July and August, which prompted the Fed to act decisively. - Revised Rate Cut Projections:
Hatzius reveals that Goldman Sachs has updated its forecast to reflect a series of consecutive 25 basis point cuts stretching from November 2024 through June 2025. By mid-2025, the federal funds rate is expected to hit a terminal range of 3.25%-3.5%, faster than initially anticipated. This forecast aligns with the Fed’s updated dot plot projections but indicates a more aggressive pace of easing. - Market Pricing and Uncertainty:
The bond market is pricing in rate cuts for the next few FOMC meetings, reflecting some uncertainty over whether additional 50 basis point cuts will be necessary. Although today’s cut has alleviated some inflation concerns, labor market trends and economic data will heavily influence future decisions.
Hatzius emphasizes that the decision between a 25 or 50 basis point cut in November remains a close call. The determining factor will likely be the next two employment reports, specifically the unemployment rate, which the Fed considers one of the most important indicators moving forward.
Conclusion
The Fed’s unexpected 50 basis point rate cut represents a significant shift in its monetary policy, reflecting a growing focus on balancing inflation control with labor market risks. Experts from First Trust Economics and Goldman Sachs offer valuable perspectives on how this decision could shape the economic landscape in the months ahead.
The key takeaway from both analyses is the importance of monitoring the money supply and labor market data as future rate cuts unfold. If M2 growth remains modest, the Fed may have more room to continue easing without sparking inflationary pressure. However, should the money supply rapidly increase, there is a real risk of inflation re-igniting, requiring the Fed to adopt a more cautious approach.
For now, the Fed is signaling a steady pace of cuts, with further action likely before the end of 2024. As the economic landscape evolves, it will be crucial for businesses, investors, and policymakers to stay informed of these developments. We will continue to monitor the Fed’s actions and their potential impact on the broader economy.