What the Fed Interest Rate Cut Means for You

I am sure you have heard that the Federal Reserve decided to cut rates for the first time since 2020 last week.  The debate over whether the Fed would cut rates by 25 or 50 basis points (bps) has been resolved, as they announced a 50 bps cut last week. This reduced the target range for the federal funds rate from 5.25%-5.50% to 4.75%-5.00%. This was the first rate cut since March 2020, following over two years of rate hikes. The Fed’s updated 2024 forecast indicates another 50 bps of cuts, with the year-end rate expected at 4.375%.

There are two Fed meetings left in 2024, in November and December. Notably, Fed Governor Michelle Bowman was the sole dissenter in today's decision, as she remains one of the most hawkish members.

In their statement, the Fed acknowledged that inflation is “making further progress” and shifted focus toward concerns about the labor market, describing job gains as “slowed.” Additionally, they expressed greater confidence that inflation is moving sustainably towards the 2% target, indicating a gradual shift in priorities from inflation to employment conditions.

Regarding the neutral rate, the Fed raised their long-term forecast from 2.562% to 2.875%, reflecting the recognition that the post-pandemic economy operates differently than the pre-COVID economy. However, the neutral rate remains below the current Fed Funds rate, suggesting restrictive monetary policy could persist into 2026, depending on labor market data and inflation trends.

On inflation, the Fed reduced their 2024 core PCE forecast from 2.8% to 2.6%, and it is currently tracking at 2.6%. Projections for 2025 and 2026 were unchanged at 2.2% and 2.0%, respectively. Labor market forecasts were adjusted, with the unemployment rate now expected to reach 4.4% by the end of 2024, reflecting potential softness in the job market.

GDP growth was forecasted at 2.0% for 2024, down slightly from June's 2.1% forecast. However, the Fed maintained a 2.0% growth outlook for both 2025 and 2026, reinforcing their belief in a soft landing for the economy.

In summary, the Fed's 50 bps rate cut marks a significant step toward easing restrictive policy, with more cuts anticipated. Their focus is now shifting from inflation to the labor market, and the overall risk of recession appears to be reduced. While rates are moving towards neutral, the exact neutral rate remains a topic of debate.

What’s the impact to the stock market?

At a high level, it isn’t so much the actual cutting of rates that worries Wall Street, but why the Fed is cutting rates. If the Fed is cutting rates to stave off an imminent recession or mitigate the impact of an ongoing recession, we are likely in an environment where corporate revenues and earnings are under pressure, and in turn, stock prices. But if the Fed is cutting rates because the economy is slowing but still expanding and inflation is moderating, we are likely in an environment where revenues and earnings are growing, and that growth, along with a more benign monetary policy environment, should support stock prices.

That all said, the tricky thing about looking at rate-cutting cycles and historic market returns is that different folks on Wall Street define rate cutting cycles differently. One article in a leading business publication recently noted that since 1970, the S&P 500 has been higher 16 out of 23 times six months on from the first Fed Funds rate cut. For the purposes of this note, we used the same jumping off point but zeroed in on rate-cutting cycles that we thought coincided with meaningful inflection points for the economy; based on our math, the S&P 500 was up 5 out of 8 times six months on from the first Fed Funds rate cut, with an average return of 6.4% (see chart). If the economy can hang in there, U.S. stocks should, too. We continue to think markets are biased higher into year-end.