Highly anticipated and hotly contested, yesterday’s Federal Reserve (Fed) decision may prove to be one of the most impactful and surprising coming out of a scheduled meeting in the last decade. In recognition of the need to embark on a shift to a more accommodative stance, the Fed lowered the fed funds target rate by 0.50% to a range of 4.75% to 5.00%. Justification of the decision to move rates lower was referenced in the statement, namely that the FOMC “has gained greater confidence that inflation is moving sustainably toward 2%.” In addition, the statement very explicitly reflected the Fed’s dual mandate, asserting that the FOMC is “strongly committed to supporting maximum employment and returning inflation to its 2 percent objective.” While all of the voting members of the FOMC were in favor of a rate cut, Michelle Bowman proved the only dissenter to the 50-basis point move, preferring a more measured 25 basis point cut; this marked the first dissent by a Fed governor since 2005.

As it relates to future monetary policy actions, the updated dot plot reflects another 50 basis points in cuts by the end of 2024 as well as 100 basis points in cuts by the end of 2025, implying, in our view, that the fed funds rate target will be between 3.25% and 3.50% by the end of next year. This compares favorably with June’s expectation that rates would still be above 4% by the end of 2025. In addition to the dot plot, the Fed released its updated Summary of Economic Projections which is essentially a representation of each FOMC member’s view on various economic metrics. Changes from the June dot plot include a modest increase in the unemployment rate forecast for this year and next with the median coming in at 4.4% for both years. In addition, there was a meaningful decline in core PCE expectations for both this year and next with the members coalescing around 2.2% by the end of 2025 and a return to the 2% target by 2026. We believe the consistency in terms of GDP expectations was notable; expectations for growth in both 2025 and 2026 were maintained at 2.0%.

Fed Chair Jerome Powell’s comments during the press conference were colored by his desire to justify the magnitude of yesterday’s cut as well as the Fed’s belief that a soft landing can still be achieved. The Fed, as voiced by Powell, believes that it was correct to maintain restrictive policy to help restore the supply/demand imbalances in the economy and that the upside risk to inflation has diminished as a result of this normalization particularly in the labor market. Conversely, Powell admitted that the downside risks to employment have increased – no surprise to economists who have digested the last several employment reports, a meaningful revision to trailing twelve-month payrolls, and the anecdotal data available through ISM surveys and the Beige Book. As a result, Powell stated that he was “very pleased” in the decision to make a strong move in this meeting and that despite several questions implying that the Fed was already behind, he believes that the 50 basis point move should be viewed as a “sign of commitment” not to fall behind, which as translated means to stave off a sharp increase in unemployment.

While there was much conjecture around the magnitude of the cut, markets seem a bit unsure of how to react now that the decision is in writing. As we wrote in our note on payrolls on September 6th, the decision to cut rates aggressively could be both cheered or feared by investors – and it would appear we got a bit of both in yesterday’s post-release trading session. We believe lower rates should be positive for both corporate and consumer borrowers and could ignite a resurgence in borrowing – but likely with a bit of a lag. Alternately, fears of a sharper deceleration in demand and economic activity could likely transmit fairly readily to the labor market as job vacancies are well off their post-pandemic highs and immigration has pushed up the number of job seekers over the last two years.

Admittedly, U.S. equities and bonds have rallied meaningfully up through yesterday’s announcement, and there may just be a bit of repositioning occurring now that the first step towards lower rates has been achieved. The Fed may not have yet declared that their mission to deliver a soft landing has been accomplished, but U.S. investors in particular have been increasingly constructive on risk assets as the threat of a recession has diminished over the last 18 months. What is clear is that the Fed, notwithstanding an unexpected resurgence in inflation due to forces other than wage growth, believes that growth will persist and that prices and costs will stabilize back closer to pre-pandemic levels but that it also stands ready to loosen the shackles of higher rates at this point in the economic cycle.

As such, investors may consider a review of positioning, particularly in areas such as cash and short duration fixed income which are unlikely to deliver the same level of return over the near-to-mid-term as they have generated over the prior two years. In addition, we note that the broadening out of performance in the U.S. equity market could be aided by a lower rate environment, and we encourage investors to review their exposures to ensure that the concentrations which may have built up over the prior two years are not inhibiting participation in this rotation. In short, we believe that we are at an inflection point for U.S. monetary policy as well as fiscal policy, and we stand ready, supported by the depth and breadth of our global investment teams, to identify both the risks and the opportunities presented in order to deliver on our commitment to our clients.