Fed Seems to Panic With Aggressive Start to Easing Cycle

On Wednesday afternoon, the FOMC cut its benchmark short-term interest rate by 50 basis points, taking its target range down to 4.75% to 5%, from 5.25% to 5.5%. 

This was the first cut made by the U.S. central bank in over four years. Additionally, in the economic forecast, the FOMC, at the median, projected a fed funds rate of 4.4% by year's end — the implication there would be a target range of 4.25% to 4.5%, meaning that there is likely an intention to shave another 50 basis points off of that range over the next two meetings. 

Perhaps importantly, there was dissension in the ranks. Fed Gov. Michelle Bowman, who is thought of as a policy hawk, dissented in favor of a 25 basis point cut rather than the 50 basis points that the committee went with.

Dissecting the FOMC Statement

The FOMC's official policy statement was no cut-and-paste job. The language made clear that this Fed intends to take borrowing costs lower than they have been in quite some time. 

The first paragraph noted that "job gains have slowed," which is a change from "job gains have moderated" from the July 31, 2024 statement. Additionally, inflation "made further progress" toward the Fed's 2% target, rather than "some further progress."

In the second paragraph, there was almost a complete rewrite: 

"The Committee has gained greater confidence that inflation is moving sustainably toward 2 percent, and judges that the risks to achieving its employment and inflation goals are roughly balanced." 

This is more dovish than July's "employment and inflation goals continue to move into better balance."

Interestingly, the Fed's quantitative tightening program will keep on keeping on, drawing potential liquidity ($25 billion worth of treasuries, $25 billion worth of MBS securities) out of the economy every month as the FOMC aggressively eases policy on the interest-rate front.

New Quarterly Economic Projections

I think it worth noting that the FOMC took their median projection for 2024 GDP down to 2.0% from 2.1% on June 12, 2024. I think it also worth noting that the FOMC sees a 2% GDP in 2025, 2026 and 2027, meaning that they very likely have no clue.

The FOMC, at the median, now sees the unemployment rate at 4.4%, up from 4% in June. The Fed sees unemployment remaining at 4.4% in 2025 and then plunging to 4.3% in 2026 and then dropping further to 4.2% in 2027. Again, they know nothing.

The FOMC sees headline PCE inflation at 2.3% and core PCE inflation at 2.6% for 2024. Then, PCE inflation at both the headline and the core, remains between 2% and 2.2% forever and ever. And ever. Not kidding.

The only thing the FOMC sees moving to any significant degree over the next few years is the federal funds rate. After ending 2024 at 4.4%, the FOMC, at the median, sees the benchmark rate at 3.4% for 2025, and then at 2.9% forever and ever.

Do these guys put any work into these projections? Certainly doesn't seem like it. Maybe the practice of providing an outlook that the participants obviously do not take seriously should be halted. Maybe the time period covered by these projections should at least be reduced. They have no more of a clue in regard to 2026 or 2027 than does the kid next door.

Unimpressive Press Conference

Chair Powell was even-tempered throughout the press conference. He said that he does not think the Fed is behind and he said that the economy is in good shape. So, why the aggressive first move? If not economic, then was it political? Good questions that were not answered.

I was not very impressed by Powell at this press conference. He did not convince me that this kind of aggressive start to a policy easing cycle was necessary. He sounded like he is comfortable with where labor markets and the economy are. He said he thinks inflation is still headed to 2%.

When asked about this change from being data dependent in the past when considering changes to policy to being proactive now ahead of a serious deterioration in the data, he did not really answer the question decisively. He kind of said that he wanted to keep the economy from deteriorating.

Market Reaction

Despite Powell's protestations, equities roared out of the gate after the policy statement was released and then weakened as Powell spoke. Perhaps traders are not buying his faith in the healthy economy and slowing inflation. 

In regards to the possibility that this rate cut and the cuts that follow will work to reaccelerate consumer level inflation (remember that I have been warning that I saw some reacceleration in late 2024 into early 2025 without this policy change), gold moved much higher and then sold off as the U.S. dollar index sold of hard and then rallied. 

There has to be some concern there and we'll know more once the algorithms that control price discovery settle down. The telltale sign may be in treasury spreads. T-bills, which rallied right away and at the time of this writing had not given back much of those gains, experienced a mild collapse in yields. However, longer-term treasury notes and bonds gave up some ground, and those yields did move higher.

That said, as the Fed suppresses short-term rates and long-term rates are to be determined by free market forces in an era of extreme debt and deficits, businesses may have to borrow and roll over debt already borrowed at higher rates than one might expect in an easing cycle. This could actually slow the economy and, eventually, the markets.

At the time of publication, Guilfoyle had no positions in any securities mentioned.