How many times will the Fed cut interest rates? Here is the potential answer.

Last week, the Federal Reserve’s Federal Open Market Committee (FOMC) held a two-day meeting scheduled for September, where it discussed the state of the economy and decided whether to adjust the rate it charges banks for overnight loans.

The FOMC cut the federal funds rate (the overnight interest rate) by 50 basis points to 4.88% (the rate changes depending on circumstances, but will be between 4.75% and 5%), which was double versus the normal 25 basis point adjustment. uses. Lower interest rates are likely to have ripple effects throughout the economy, increasing consumers’ borrowing capacity, lowering interest payments and giving them higher income.

This is great news for the economy as a whole, and potentially great news for investors as well.

FOMC members also offer their individual assumptions about where the fed funds rate will be in the future. The consensus of these assumptions is that interest rates are likely to be much lower by the end of this year and even lower again in 2025 and 2026. That’s how many cuts could be on the table.

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Why is the Fed cutting rates?

The Federal Reserve has a dual mandate set for them by legislation. The first mandate calls for it to take the necessary steps to keep the consumer price index (CPI) measure of inflation rising at an annualized rate of 2 percent. The second mandate calls for taking the necessary measures to maintain a high level of employment (although the central bank does not specify a target for the unemployment rate, it is believed to be around 4%-4.5%).

A combination of pandemic-related factors, including US government stimulus, historically low interest rates and supply chain disruptions have driven annualized CPI to a 40-year high of 8% in 2022. It has prompted one of the most aggressive campaigns rate hike in Fed history, which took the federal funds rate to a two-decade high of 5.33 percent in August 2023 — where it remained until last Wednesday.

The Fed is now reversing its efforts to slow the economy as the CPI is nearing its 2% target, with the latest reading at 2.5%. Additionally, the labor market has cooled somewhat, with the unemployment rate currently at 4.2%, after starting the year at 3.7%. Fed Chairman Jerome Powell says the risk of further damage to the labor market has increased, hence the 50 basis point interest rate cut.

As long as the CPI continues to decline, investors should focus on the nonfarm payrolls report, which is released on the first Friday of each month. If the economy adds fewer jobs than economists expect, or if the unemployment rate continues to rise, more rate cuts are likely.

Here’s how many times the Fed could cut rates as things currently stand

Once a quarter, each FOMC member sends a Summary of Economic Projections (SEP). It includes a forecast for economic growth, inflation, the unemployment rate and the federal funds rate for the next three years.

The most recent SEP, which was released last week, suggests that the federal funds rate is most likely to end 2024 somewhere between 4.38% and 4.62%. The low end of this range implies that the Fed could cut rates by another 50 basis points before the end of this year. The SEP also points to a federal funds rate between 3.13% and 3.62% through the end of 2025, implying another 125 basis point cuts based on the lower end of that range. There could be one or two more cuts in 2026, with the federal funds rate expected to settle somewhere between 2.88% and 3.12%.

Investors predict that there will be more cuts in the near term. On the basis CME Grouphis FedWatch tool, there could be:

• Two more cuts in 2024: 25 basis points in November, followed by 50 basis points in December, for a total of 75 basis points.
• Five cuts in 2025: 25 basis points each at meetings in January, March, May, June and September, for a total of 125 basis points.

It’s important to remember that investors and FOMC members regularly change their views as new economic data emerges, so the predictions above may not be the same a month from now, with let alone next year.

Here’s what it means for the stock market

Interest rate cuts are usually bad for savers because they reduce the yield on risk-free assets like cash savings accounts and Treasury bonds. These lower returns tend to encourage savers to look for alternative investment options. This is part of the reason why lower rates are great for growth assets like stocks.

Lower rates allow companies to borrow more money for the same relative cost to fuel their expansion and reduce interest on existing loans. Rate cuts can also trigger an increase in consumer spending. All of these things can be a direct tailwind for corporate earnings, and earnings drive stock prices.

Therefore, if the Fed cuts rates for the next two years, as expected, the stock market will likely be a great place to invest. Only a recession or economic shock would throw a wrench in the works. There doesn’t appear to be one on the horizon, nor does the Fed expect one based on SEP forecasts, but the weakening job market is something to watch.

For now, putting money to work in the stock market seems like the way to go.