Fed Enters Tricky Terrain: Rate Cuts in a Decent Economy

Fed Enters Tricky Terrain: Rate Cuts in a Decent Economy By Hardika Singh

The Federal Reserve is poised to start cutting rates on Wednesday, and over time those cuts will ripple their way through the economy.

The mechanics are, in some ways, clear. Borrowers pay less on their debt. Savers get less for their cash. But that is just the broad brush, and the details of how it will all work out is an open question.

Every rate-cutting cycle is different, and the economy's response is both long and variable. Milton Friedman, speaking before Congress in 1959, likened changes in Fed policy to "a water tap that you turn on now and that then only starts to run six, nine, 12, 16 months from now."

What's more, there isn't a clear historical template for the current situation. Usually, by the time the Fed starts cutting rates, the economy is already in pretty big trouble. That isn't the case now. The labor market has cooled but still looks decent, and the economy has been posting solid growth.

In fact, it is a better economy than it was even in 1995-arguably the one time the Fed convincingly achieved a so-called soft landing, where inflation comes down but unemployment doesn't spike.

"We don't have a lot of examples of cutting in a healthy economy, in one that's not showing serious signs of distress," said Jon Faust, who until early this year was senior special adviser to Fed Chair Jerome Powell.

That could make for atypical economic responses to the Fed's expected cut Wednesday.

Read more .

Top News On the Eve of Fed Rate Cuts, Wall Street Grows Skittish

Investors are trying to discern whether recent economic data is simply showing a hot economy returning to normal or the early glimmer of a recession. Analysts say stock and bond markets appear to disagree on the answer.

That disconnect is setting up one of the most anticipated Fed meetings in recent memory. Investors will be closely watching Chair Jerome Powell's press conference for commentary on the economy, along with the so-called dot plot, where Fed officials forecast rates over the longer term.

"Markets have been on edge for the last month or two," said Rick Rieder, chief investment officer for fixed income at BlackRock. "You've seen bonds move rapidly from a sanguine view to recession."

Traders in interest-rate derivatives are now pricing in a benchmark rate of about 2.75% by the end of next year, down from about 5.25% now. That would equate to 10 standard-size, quarter-point rate cuts-something the Fed is likely to do only in response to a recession.

Stocks, meanwhile, offer a much more bullish view. The S&P 500 has posted several ugly one-day selloffs in the past six weeks but has bounced back each time. The index is up 18% for the year and just 0.7% from its record high.

Read more .

U.S. Economy Why a Fed Rate Cut Won't Cure the Housing Wealth Gap

The U.S. housing market is sharply divided between those who own and would-be buyers who can't afford a home. The Federal Reserve's widely expected rate cut next week will do little to close the gap between the two . A reduction in short-term interest rates would directly translate to lower rates for home equity lines of credit, making it cheaper for millions of homeowners to tap into their housing wealth.

Where to Put Your Money When the Fed Cuts Rates

The Federal Reserve is expected to start cutting rates. Lower interest rates on high-yield savings accounts and money-market funds will follow, likely within days or weeks . Yields on certificates of deposit have already started dropping.

Pro Take: Don't Fear the Unemployment Rate

The recent uptick in the unemployment rate has raised fears that the Federal Reserve's tight monetary policy is starting to hurt the labor market and the overall economy, just as the central bank is moving toward interest-rate cuts.

That could be. But there's also a possibility the unemployment rate is rising for more benign reasons. In fact, as counterintuitive as it sounds, a further uptick in the unemployment rate could be a good sign, rather than a cause for alarm. Read more .

Forward Guidance Monday (all times ET)

8:30 a.m.: Empire State manufacturing survey

Tuesday

8:30 a.m.: Retail sales

9:15 a.m.: Industrial Production and Capacity Utilization

10 a.m.: Business inventories

10 a.m.: NAHB Housing Market Index

Commentary Interest Rates Are Too High. The Fed Should Cut by a Half Point.

The Federal Reserve's interest-rate decision this week looks more difficult than it should be. The real question isn't how much to cut, but where rates ought to be. The answer is much lower. That argues for a half-point cut, writes Greg Ip for The Wall Street Journal.

The case for a bigger cut starts by examining why the Fed's short-term rate target is now 5.25% to 5.5%, the highest since 2001. The Fed pushed it there last summer because underlying inflation was well above 3% and, with the labor market overheated, the Fed was afraid it would get stuck there. It was willing to cause a recession to prevent that.

Fast forward to today, and some key underlying measures of inflation are below 3%, some within range of the Fed's 2% target. The labor market is cool, if not actually cold. A recession now serves no useful purpose.

True, there isn't much evidence a recession is in the offing. But waiting for that evidence is tempting fate. Read more .

Research Size of Fed's Rate Cut This Week Will Be Indicative for Rest of 2024

The size of the Federal Reserve's first interest-rate cut will impact the overall reduction in rates for this year, Deutsche Bank market strategist Jim Reid says in a note. If the Fed cuts rates by 25 basis points on Wednesday, Deutsche Bank would expect the Fed's forecasts to show a total of 75 basis points of cuts this year. If the Fed opts for a 50 basis-point reduction, they would expect forecasts to show 100 basis points of cuts through year-end. How much the Fed will cut rates this week remains uncertain, with money markets pricing a 59% probability of a 50-basis-point cut and 41% for a 25-basis-point cut, according to LSEG Refinitiv. - Emese Bartha

Basis Points Consumer sentiment rose to a four-month high in September, just ahead of the U.S. presidential election, as expectations about future inflation fell to the lowest level since 2020. U.S. import prices fell back a little last month as fuel prices decreased, according to Labor Department data set out Friday. Prices were 0.3% lower in August than in July, when they increased 0.1%. Extreme heat shattered temperature records and pushed electricity demand to new highs this summer. The U.S. power grid has held up, but in many places the margin for error is shrinking . The share of Canadians reporting a high-level of life satisfaction has declined to under half, with inflation and higher borrowing costs weighing on household moods, according to a Statistics Canada survey. The European Union's economic planners might want to shout "U.S.A., U.S.A.!" Ironically, though, emulating America today would involve more state intervention . The People's Bank of China is expected to hold the one-year medium-term lending facility rate at 2.3% and the one-year loan prime rate at 3.35% later this week, DBS Group Research writes in a report. As China sits on the precipice of deflation, Wall Street economists are calling for more fiscal stimulus in the country. But Beijing may still not act boldly enough . China has for years had one of the lowest retirement ages among major economies. But now, China's next generation will have to work longer. Bank Indonesia is likely to keep the policy rate unchanged at its meeting this week, ANZ Research writes in a note, but adds that the decision will be a close call. Moscow's forces in Ukraine since 2022 have occupied some of Europe's most fertile farmland. The occupiers have either seized harvests or bought them cheaply , often forcibly. About Us

WSJ Pro Central Banking brings you central banking news, analysis and insights from WSJ's global team of reporters and editors. This newsletter was compiled by markets reporter Hardika Singh in New York. Send your tips, suggestions and feedback to [hardika.singh@wsj.com].

This article is a text version of a Wall Street Journal newsletter published earlier today.

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September 16, 2024 07:15 ET (11:15 GMT)

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