FOMC Cuts Funds Rate 25 BP As It ‘Recalibrates’ Policy Rate Closer To ‘Neutral’

– Powell: FOMC Will Move ‘Carefully, Patiently’ To ‘Neutral” Policy Stance

By Steven K. Beckner

(MaceNews) – The Federal Reserve continued to ease monetary policy Wednesday, albeit more incrementally, even though inflation remains above target amid relatively strong economic conditions, and even though financial markets have become more optimistic about the economy in wake of the presidential election.

The Fed’s policy-making  Federal Open Market Committee lowered short-term interest rates for a second straight meeting, but only by a quarter percentage point, after slashing them by half a point in mid-September.

Chair Jerome Powell said that “even with this cut policy is still restrictive” and made clear the FOMC will keep reducing the key federal funds rate over the next two years – eventually to “neutral” – but in a cautious, conditional fashion, because the FOMC wants to avoid cutting rates either too quickly or too slowly.

Returning to unanimity, the FOMC cut its policy rate by 25 basis points to a target range of 4.5% to 4.75% after a 50 basis point reduction on Sept. 18 had taken the funds rate to a range of 4.75% to 5.00%.

Gov. Michelle Bowman, who dissented against a 50 basis point cut on Sept. 18, voted with the majority this time for the smaller move.

Even as it eased its interest rate stance, the FOMC continued its “quantitative tightening” policy of shrinking the Fed’s balance sheet.

In its policy statement, the FOMC said it “judges that the risks to achieving its employment and

inflation goals are roughly in balance.” Conspicuously absent was previous language that the FOMC had “gained greater confidence that inflation is moving sustainably toward 2%.”

The FOMC statement also modified its characterization of labor market conditions, now saying

they “have generally eased, and the unemployment rate has moved up but remains low.” By contrast, the September statement said, “Job gains have slowed, and the unemployment rate has moved up but remains low.”

The statement said inflation has “made progress” toward the 2% goal but continued to call it “somewhat elevated.” The FOMC also repeated it is “attentive to the risks to both sides of its dual mandate.”

In taking another step to dial back monetary restriction, the FOMC left the door open to further rate cuts but did not prejudge that an additional rate reduction will be made at the FOMC’s Dec. 17-18 meeting. “In considering additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks,” the policy statement repeated.

In his post-FOMC press conference, Powell said he and his colleagues will make rate decisions “meeting by meeting” and is “not on a preset course.”

Explaining the FOMC’s post-election decision, Powell repeated that he and his fellow policy-makers have become more confident that inflation is moving “sustainably” toward the Fed’s 2% target, but have also become more concerned about downside risks to the “maximum employment” side of its dual mandate.

Powell indicated the FOMC will proceed judiciously in pursuit of its dual mandate goals, as he elaborated on its second straight rate cut.

“This further recalibration of our policy stance will help maintain the strength of the economy and the labor market and will continue to enable further progress on inflation as we move toward a more neutral stance over time,” he said.

“We know that reducing policy restraint too quickly could hinder progress on inflation,” he continued. “At the same time, reducing policy restraint too slowly could unduly weaken economic activity and employment ….”

So, Powell said the FOMC must be prepared to accelerate, decelerate or even pause its rate cuts, depending on economic conditions.

“As the economy evolves, monetary policy will adjust in order to best promote our maximum employment and price stability goals,” he said. “If the economy remains strong and inflation is not sustainably moving toward 2%, we can dial back policy restraint more slowly.”

On the other hand, he added, “if the labor market were to weaken unexpectedly or inflation were to fall more quickly than anticipated, we can move more quickly.”

In September, Fed officials revised up their estimate of the “longer run” or “neutral” rate to 2.9%, having previously raised it from 2.5% at the end of last year. (The neutral rate includes the Fed’s 2% inflation target plus an estimate of the “real equilibrium short-term interest rate” or r*.)

Powell said the Fed can’t be sure exactly where the “neutral” rate will ultimately prove to be and suggested the FOMC will need to feel its way along toward ultimate neutrality.

“(A)s we move ahead, we are prepared to adjust our assessments of the appropriate pace and destination as the outlook evolves,” he said. “ So for example, if we were to see the labor market deteriorating, we’d be ready to move more quickly.”

“Alternatively, as we approach levels that are neutral or close to neutral, it may turn out to be appropriate to slow the pace at which we’re dialing back restriction,” he went on. “ We haven’t made any decisions about that, but that’s certainly a possibility.”

In a later reference to the FOMC’s eventual desire to make monetary policy “neutral,” Powell said, “Nothing in the economic data suggests that the committee needs to be in a hurry to get there. We’re seeing strong economic activity, we are seeing ongoing strength in the labor market, we’re watching it carefully, but we do see maintaining strength there.”

“And so we think that the right way …. to find neutral, if you will, is carefully, patiently,” he added.

“We don’t know exactly where that (neutral) is, we only know it by its works,” Powell said. “We’re pretty sure it’s below where we are now, but as we move further, there will be more uncertainty about where that is and we’re going to move carefully as this goes on so that, you know, we can increase the chances that we will get it right.”

Powell said the FOMC will try to take a “middle path” between the risks of cutting rates to rapidly and reviving inflation and cutting them too slowly and damaging the economy and labor markets.

The Fed action follows a flurry of statistical reports showing persistent inflation amid robust economic activity and low unemployment.

Last Wednesday, the Commerce Department’s advance report on third quarter gross domestic product estimated 2.8% annualized GDP growth, fueled by strong consumer spending. Though two tenths lower than in the second quarter, the pace continued to well exceed the Fed’s 1.8% estimate of the economy’s longer run growth potential.

The following day, that department said its Personal Consumption Expenditures (PCE) index — the Fed’s preferred inflation gauge — rose 0.2% overall and 0.3% excluding food and energy in September. Year over year, the PCE was up 2.1%, close to the Fed’s 2% target. But the more closely watched core PCE rose 2.7%. The Dallas Fed’s respected Trimmed Mean Price index was also up 2.7%.

An even worse September inflation reading had previously come in the form of the core consumer price index, which was up 3.3% from a year ago.

Then Friday, the Labor Department’s reported nonfarm payrolls grew a mere 12,000 in October — smallest gain since December 2020. But the employment numbers were said to have been heavily skewed by storms and strikes. The unemployment rate remained at 4.1%. And average hourly earnings increased 0.4%, higher than the expected, and were up 4% from a year earlier.

The rate cut also follows a stunning election victory by former President Donald Trump, which triggered a record-breaking surge in stock prices, reflecting investor optimism about the economy’s prospects. Some have speculated that Trump tax, trade and regulatory policies could influence the Fed to cut rates less than previously projected.

Powell was circumspect in addressing that issue, saying that the Fed staff and the FOMC will model and assess the economic implications of Trump policy changes as they develop and take them into account in setting rates. But he suggested it is much too early to come to any conclusions and declined to comment on the election.

He again said federal fiscal policy is on a “sustainable” path but refused to go beyond that to talk about how prospective tax changes might affect the federal deficit and debt.

He did say emphatically, however, that he will not resign as Fed chairman if asked to do so, and he asserted that legally Trump cannot force him out of the job.

Asked about the recent spike in bond yields, Powell said the Fed does take yields and financial conditions more generally into account in setting monetary policy but did not seem alarmed at the rise in yields, noting they are still well below 5%.

Wednesday’s rate hike marks another chapter in the roller coaster ride of monetary policy in recent years..

After leaving the funds rate in a target range of 5.25% to 5.50% for more than a year, the FOMC on Sept. 18 cut it by 50 basis points to a range of 4.75% to 5.00%, encouraged by a combination of more favorable inflation data and softer labor market conditions. It had previously tightened by 525 basis points, after a long stay near zero, together with unprecedented deficit spending and covid-related supply chain issues had driven inflation above 9%.

At the time of the September meeting, the 19 FOMC participants projected the funds rate will end 2024 at a median 4.4%, implying 50 basis points of further reductions to a target range of 4.25% to 4.5% over the final two meetings of the year. They projected the funds rate will fall to a median 3.4% by the end of 2025 (a range of 3.25% to 3.5%), and to 2.9% by the end of 2026 (a range of 2.75% to 3.0%) — the latter rate coinciding with the FOMC’s upwardly revised estimate of the “longer run” or “neutral” funds rate.

The FOMC will not publish another funds rate “dot plot” until its Dec. 17-18 meeting, as noted by Powell, who declined to say whether he still thinks 100 basis points of rate cuts will be appropriate next year.

While reducing the funds rate, the FOMC continued “quantitative tightening.” The FOMC instructed the New York Federal Reserve Bank to roll over principal payments from the Treasury securities exceeding $25 billion per month. And it ordered the open market trading desk to reinvest principal payments from agency and agency mortgage‑backed securities exceeding $35 billion per month – for a total of $60 billion in monthly shrinkage in securities holdings.

Powell gave no indication the FOMC is ready to alter the QT strategy.

In conjunction with the 25 basis point increase in the federal funds rate, the FOMC lowered the minimum bid rate on standing overnight repurchase agreement operations from 5.0% to 4.75%.  The offering rate on standing overnight repurchase agreements was lowered from 4.8% to 4.55%. 

At the same time the Fed Board of Governors reduced the primary credit rate, at which it lends to member banks at the discount window, by 25 basis points to 4.75%. The rate of interest paid to banks on reserve balances was reduced from 4.90% to 4.65%.