Weekly Economic Trends and Indicators

The Headline

Last Wednesday, the Federal Open Market Committee (FOMC) of the Federal Reserve voted to decrease the target range for the federal funds rate by ½ percentage point to 4.75 to 5%. This was the first decrease in the fed funds rate since 2020 and comes after a series of rate increases from March 2022 through July 2023. The range had been 5.25 to 5.5% since that time.

The Details

This move comes after a year of speculation about when and how large the first rate cut would be. While many market participants wanted a rate cut early this year, Fed Chair Jerome Powell and the committee repeatedly stated that more progress needed to be made on inflation reduction before monetary policy could begin to ease.

This summer, as it became clearer that a rate cut was imminent, the speculation turned to whether it would be ¼ percent or ½ percent. Most expected a ¼ percent move as a larger change might send a signal to the market that economic conditions are deteriorating faster than expected. However, in recent days, there began to be more chatter in the financial press about how a ½ percent move is necessary, but not because the economy is deteriorating rapidly. Rather, analysts claimed that a larger move is appropriate because the success at controlling inflation has lowered the neutral rate (neither contractionary nor expansionary) more than anticipated.

By Wednesday morning, the futures market was putting an equal probability on each outcome. In essence, observers in the financial markets—including professional forecasters and commentators—were saying it was basically the flip of a coin. In the end, the larger cut received the votes. While the move surprised perhaps as many as half of the professionals, far fewer were actually opposed to the action. Many observers believed that a ½ percent move was the right thing to do, even if they believed that the FOMC would take the more conservative approach.

This kind of uncertainty about an upcoming policy action is quite unusual. Fed officials normally signal their policy stance in public speeches to prevent there from being any surprises that could cause instability in the market. At the Fed’s annual Jackson Hole symposium, Chair Powell laid the groundwork for the fact that there would be a cut in September, but the size remained the object of speculation. The intensity of that speculation ramped up in the last few days during the “blackout period” where Fed officials refrain from making public statements on policy.

Most analysts believe that the ½ percent cut will improve the chances for a “soft landing” that avoids a recession. At the same time, the general feeling is that this is not likely to reverse the progress that has been made on inflation. Retail sales figures reported last Tuesday support the soft landing opinion as the better than expected sales suggest a GDP growth rate of around 3% for the current quarter—hardly a recession. Yet, the Fed would not make this large of a move without some amount of weakness on the horizon. More on this aspect of the decision and how it affects the economic outlook next week.

Next week: How the pace of interest rate cuts matters for the Quad Cities economy