Fed sets historic interest rate cut cycle in motion

After four years of stable interest rate policy, the Federal Reserve is expected to cut interest rates on Wednesday, marking the end of the most aggressive anti-inflation program since the 1980s. Esther George, former president of the Kansas City Fed, describes the anticipated decision as long-awaited and crucial. Specifically, a reduction of 0.25 percentage points is expected, lowering the key interest rate to a new range of 5.0 to 5.25%. Investors predominantly expect a 25 basis point rate cut, although the likelihood of a deeper cut of 50 basis points is around 50%. The current valuation trend reflects recent inflation and labor market data. The political dimension is controversial: about six weeks before the presidential elections, some Republicans are demanding that interest rate cuts should only occur after the elections. However, the Fed plans a sustained era of low interest rates until 2025 and 2026, which will facilitate borrowing for consumers and businesses. In addition to current rate decisions, the Fed will also release new projections on how often it intends to cut rates in 2024. Luke Tilley from Wilmington Trust expects two further cuts of 25 basis points each this year. At the same time, he acknowledges that larger cuts could be possible should market reactions be positive. Esther George anticipates that the Fed could cut rates by a total of 1.25 to 1.5 percentage points before taking a pause to review the economic situation. Fed Governor Chris Waller is showing flexibility and is willing to support larger cuts if the data warrants. Inflation shows declining trends, which bolsters the Fed's optimism in reaching its 2% target. Consumer price inflation was recently at 3.2%, and inflation expectations are also declining. In parallel, the labor market is slowing down. These developments prompt the Fed to focus more on the labor market. Fed Chief Jay Powell emphasized in August that the labor market is as important to the Fed as price stability. He announced that the Fed would be ready to cut rates if the labor market weakens further. Powell is also expected to repeat this message at the press conference on Wednesday. The meeting could open up several scenarios: Powell could indicate that larger rate cuts might follow if necessary to stabilize the labor market. Wilmer Stith from Wilmington Trust believes that Powell will maintain a balanced stance, while EY Chief Economist Gregory Daco supports a gradual rate-cutting policy. Although recent labor market data dispel concerns of an impending recession, there remains worry that external shocks, such as an oil price shock or a stock market crash, could leave the economy vulnerable. Nonetheless, Tilley sees a "soft landing" for the economy despite existing risks.