New era of easy money ushers in as Fed nears first rate cut of 2020

The Federal Reserve is nearing the end of an era as the central bank looks to cut interest rates for the first time in four years.

If the Fed eases monetary policy at its next meeting on September 18, as expected, it will officially mark the end of its most aggressive campaign to fight inflation since the 1980s. Its benchmark rate is currently at 5.25% until 5.5%, a maximum in the last 23 years.

The central bank’s new era of easy money is expected to last through 2025 and 2026. This shift will impact the US economy, making it cheaper for Americans to borrow what they need to buy homes and cars or for card purchases of credit.

Businesses will also find it easier to borrow to finance their operations.

“It looks like we’re starting this rate cut cycle in September at a place fed funds haven’t been in more than 20 years,” said Kevin Flanagan, head of fixed income strategy at WisdomTree. for Yahoo Finance.

“You have a whole generation of investors who have never experienced interest rate cuts at these interest rates.”

Read more: What the Fed rate decision means for bank accounts, CDs, loans and credit cards

For Fed Chairman Jerome Powell, this turning point could allow him to claim an achievement that has eluded many of his predecessors, including his inflation-fighting idol Paul Volcker.

Powell said how much he admired Volcker, who raised interest rates to 22 percent in the 1980s in an effort to control inflation. But Volcker failed to avert a recession as his high rates hurt millions of Americans and businesses.

Powell had his own Volcker moment in 2022 when he promised “pain” as the Fed took its own rate hike campaign into overdrive. Then he went through a banking crisis in the spring of 2023, which tested the central bank as it worked to ease panic among US bank depositors.

But the goal now within his grasp is the ever-so-rare “soft landing,” in which inflation falls back to the Fed’s 2 percent target without forcing the U.S. economy into a painful recession.

Esther George, former president of the Kansas City Fed, said the Fed will not finish its job until it secures its 2 percent inflation target.

“Maybe they’re on the golden path, but for me, (it’s) too early to say we know the path we’re on,” George said. “The Fed’s credibility to hit 2% is coming into focus, but we’re not there yet.”

There is still the danger that a cooling labor market could worsen, which has the potential to drag down the US economy and force the Fed to cut interest rates more aggressively.

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This is the debate that will likely define the coming days as the Fed prepares for its next meeting.

Powell signaled in his latest speech that the central bank is ready to begin its rate-cutting cycle, saying in Jackson Hole, Wyo., that “the time has come for policy to adjust.”

But he was silent on how big the first cut could be and whether it would definitely happen at the September meeting.

Atlanta Fed President Raphael Bostic told Yahoo Finance that September or November is “definitely in play” and that an initial 25 basis point cut “may be the most appropriate way forward.”

Philadelphia Fed President Patrick Harker said in another interview with Yahoo Finance that he expects the central bank to start with a 25 basis point cut, but would be open to a bigger cut if the labor market deteriorates sudden.

For now, traders are betting on a small discount to get started. The odds of a 25 basis point cut in September are now around 65%.

Read more: Fed forecasts for 2024: What experts say about the possibility of a rate cut

Playing catch up

The Fed’s multi-year fight against inflation began with what many consider a misstep and has included plenty of ups and downs along the way.

The wrong step was to think that inflation would be “transient”. That was the belief for much of 2021 as Fed policymakers watched prices rise due to pandemic dislocations and supply chain disruptions caused by the COVID-19 health crisis.

But when the price increases spread to a wider range of goods and services, it was clear that inflation was proving to be more persistent than previously thought – especially as oil prices rose after the start of Russia’s war in Ukraine.

In March 2022, the annual change in inflation, as measured by the Consumer Price Index, reached 8.5%, the highest level in 40 years. Even excluding food and energy, growth was still 6.5%, unacceptably high compared to the Fed’s 2% target.

That month, the Fed decided at its policy meeting to raise interest rates for the first time since 2018, starting with a small cut of a quarter of a percentage point.

“As I looked around the table at today’s meeting, I saw a committee that is very aware of the need to return the economy to price stability and determined to use our tools to do just that,” Powell told reporters after that meeting.

But inflation continued to heat up. Annual CPI growth rose to 8.6% in May and 9.1% in June.

The Fed then went into recovery mode, pulling the trigger on a 0.75% rate hike, the biggest in more than a quarter century. It would be the first of four 0.75% increases in a row.

As Powell grew more hawkish, he sent markets tumbling with a speech in August 2022 in which he warned that “the Fed’s overall focus right now is to get inflation back to our 2% target” and that this will cause “some pain to households”. and business.”

“Failure to restore price stability would mean much greater pain,” he added.

The Fed returned to quarter-point hikes in early 2023, defying some forecasts that a regional banking crisis roiling the financial world at the time could prevent the Fed from tightening further.

The last hike took place in July 2023, setting the federal funds rate at a 22-year high of 5.25% to 5.5%. It has been at that level ever since.

“Things are looking pretty good”

Investors began 2024 believing the Fed’s inflation-fighting campaign was over and hoping for six cuts over the course of the year.

That immediately led to tensions between the Fed and Wall Street. Fed officials have repeatedly dismissed those expectations, saying they need to see more progress on inflation before they are ready to stop raising rates.

Their caution appeared to be justified when inflation heated up again in the first quarter, prompting policymakers to revise their own forecasts for multiple cuts to just one for all of 2024.

But as inflation resumed its decline in the second quarter and unemployment began to rise, some Fed critics resurfaced.

They argued that the central bank had kept interest rates too high for too long and risked canceling the possibility of a soft landing.

Alan Blinder, a former vice chairman of the Federal Reserve and an economics professor at Princeton University, is among those who have argued that the Fed could have started cutting rates in July.

The Fed, he told Yahoo Finance, is “a little behind the curve.”

Blinder doesn’t think the chances of a recession have increased, noting that the economic data doesn’t look much different now than it did in July. But the labor market can’t cool “too much more” without a recession, he said.

“(The unemployment rate) went up smoothly – a tenth of a point. You don’t want to hold that for a year. If you do that, you’re going to go up 1.2 percentage points,” he added in an interview. .

Asked if the labor market can cool without sending the economy into a recession, the Atlanta Fed’s Bostic said, “It can and we’ll have to see if it happens.”

But a recession, he added, “is not in my view.”

Former Cleveland Fed President Loretta Mester said the central bank now has “a good chance” of getting a soft landing.

Harker of the Philadelphia Fed agreed.

“Right now things are looking pretty good,” he said.

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