By Jeanna Smialek
Earlier this week, the Federal Reserve implemented a significant interest rate reduction of half a percentage point, a noteworthy action indicating that central bankers are feeling optimistic about their success in combating inflation and are refocusing on safeguarding employment.
“Our steady strategy over the last year has yielded positive results,” stated Jerome Powell, the chair of the Fed, during a press briefing. However, he noted that “the potential upward pressures on inflation have lessened, while the risks of rising unemployment have increased.”
With this decision, the Fed has lowered rates to approximately 4.9%, a drop from levels not seen for over twenty years.
This shift is a reaction to recent trends of declining inflation and aims to prevent a significant economic slowdown that could severely impact the job market. Officials are closely monitoring a recent rise in the unemployment rate, and by initiating a substantial cut, the Fed is effectively adding a safety net against a more severe employment downturn.
Echoing that cautionary stance, the substantial reduction was paired with economic forecasts indicating a more rapid rate-cutting schedule than previously anticipated by officials just months prior. They now foresee an additional half-point cut before the year’s end.
“We intend to approach this on a meeting-by-meeting basis,” Powell commented. “This strong start reflects our confidence that inflation is decreasing.”
While Powell mentioned that the Fed is not quite ready to declare a complete victory over inflation, he expressed that officials are “encouraged” by the advancements made thus far.
The rate reduction on Wednesday signifies a preliminary success. To date, the Fed has successfully moderated inflation without triggering significant economic challenges. Although the unemployment rate has edged up, it has not surged dramatically. Hiring continues, albeit at a slower pace, and consumer spending remains robust. Overall, economic growth continues to be strong.
This durability has led Fed officials to feel optimistic about achieving a historically uncommon “soft landing,” in which the economy can stabilize without entering a recession.
“We are striving to create a scenario where we restore price stability without experiencing the kind of acute rise in unemployment that has occurred in the past,” Powell remarked, while asserting that he has “greater confidence” in the Fed’s capabilities to accomplish this.
Nevertheless, the central bank’s mission is far from done.
Elevated interest rates inhibit economic activity by making borrowing costs for purchasing homes or expanding businesses higher, which dampens demand and price surges. Yet, they also suppress hiring. For this reason, the Fed has sought to navigate a delicate balance, aiming for sufficient growth slowdown to normalize price increases without overcooling the economy, leading to soaring unemployment and a potential recession.
Policymakers still have to determine the extent and pace of interest rate reductions in the coming months and years to achieve these objectives. This context makes Wednesday’s economic projections particularly significant, as they offer insight into what Fed officials anticipate doing next.
Fed officials forecasted that they will reduce interest rates to 4.4% by year’s end — notably lower than the 5.1% expected in June, when they last shared economic projections. Furthermore, they project another full percentage point decrease by the end of 2025, bringing costs down to 3.4%.
For the White House, the Fed’s announcement was seen as a positive sign. After years marked by high price growth, this action symbolizes a significant indication that a return to stable inflation is on the horizon.
“Although this news is encouraging for Americans who have faced the brunt of high prices, my attention remains on the tasks ahead to further reduce prices,” stated Vice President Kamala Harris, the Democratic nominee.
In contrast, the Fed’s choice to trim rates mere weeks before the 2024 presidential election drew criticism from former President Donald Trump, the Republican candidate.
“Reducing it by that extent, assuming they’re not merely engaging in politics, indicates the economy must be in dire straits, or they are playing politics,” Trump remarked on Wednesday, addressing reporters at a cryptocurrency-themed bar in New York City.
Fed officials operate independently from political influences and have consistently stated that they disregard the political timeline in their decision-making. Nevertheless, although they may have little control over the Fed’s actions, incumbents generally prefer to see low rates during their term.
In addition to offering a reassuring message about the economy — at least in this instance — lower Fed rates also benefit consumers. Anticipation of the central bank’s rate cuts has already begun to lower mortgage rates, making home buying slightly more accessible for average households. (They are unlikely to revert to the exceptionally low levels seen in 2020, as the Fed does not foresee rate reductions back to near-zero levels.)
The Fed will need to move cautiously in the forthcoming months.
Some economists have expressed concerns that the central bank may already be in jeopardy of lagging behind, as unemployment has increased to 4.2%, which, while low by historical standards, has risen notably from 3.4% at the beginning of 2023.
Others worry that by rapidly lowering interest rates, the Fed might inadvertently accelerate the economy, causing inflation to remain at an uncomfortably elevated rate. One Fed governor, Michelle W. Bowman, opposed Wednesday’s cut, preferring a more moderate approach.
During his press conference, Powell emphasized that the Fed is prepared to adjust the pace of rate cuts depending on whether the economy proves weaker or stronger than forecasted. Policymakers aim for a successful adjustment, he suggested, and are becoming more optimistic that they can achieve it.
“The U.S. economy is positioned well, and our decision today aims to maintain that standing,” Powell stated.
However, while the Fed’s reduction marked a significant milestone — and a step on the journey — economists and analysts cautioned that it is still premature to declare that the Fed has successfully executed a soft landing.
“Claiming victory now is akin to asserting you’ve landed when you’re still mid-air on a ski jump,” noted Gennadiy Goldberg, head of U.S. rates strategy at T.D. Securities. “We are still very much in the air.”
