• Third cut of the easing cycle, dropping the Fed Funds range 25bp.
• New Fed Funds range is 4.25% to 4.5%. 
• Committee projection for 2025 is only 2 rate cuts.
• Committee thinks rate at end of 2025 is 3.9%.
• Powell thinks the outlook for the economy is “very bright.”.

As expected

This afternoon, the Federal Reserve Open Market Committee lowered the range for its Federal Funds rate by a quarter of one percent. The new range is now between 4.25% and 4.5%. Today’s action marks the third cut in this cycle. Combined, the three reductions have lowered the Federal Funds range a full 1% since September 18. Chair Powell stated in his press conference that the vote to cut was a “close call.” Beth Hammack, President of the Cleveland Fed, voted against the rate cut. We are interested in hearing from Michelle Bowman in the coming days; she voted for today’s rate cut, but against last month’s cut.

As in his September press conference, Chair Powell focused the inflation story on how far the inflation rate has come down over the past two years. He very briefly mentioned that inflation has not reached the Fed’s 2% goal. To his credit, he did acknowledge that inflation has trended sideways over the past year. The Committee’s quarterly economic update shows that they still believe 2% inflation will be achieved by the end of 2026.

The charm?

Markets always look ahead to “what’s next?” The Committee member’s projections of short-term rates center around 3.95% for 2025, implying two more quarter-point reductions next year. Five of the 19 members projected a higher rate, implying fewer than two cuts. Is the third time the charm to end this cycle? Recent speeches by Committee members suggest that they are comfortable with today’s rate levels. Powell repeatedly characterized the economy as steady or strong in today’s press conference.

Powell emphasized that further cuts would be on the table if job creation falls, or inflation ticks higher. Powell also thinks monetary policy is still restrictive. His definition is narrow by economist standards: just that the Fed Funds rate remains far above inflation (4.25%-2.8%). He believes the gap should be much narrower. There is also an ongoing debate about the neutral rate level. This is the rate where Fed Funds would not be so low to stimulate inflation or so high to throttle parts of the economy.

The real charm for our economy is to keep nominal growth above the interest cost on our debt. If nominal growth (inflation of 3% plus real GDP growth of 3%) of 6% can be sustained for the next decade, and our debt interest costs hover around 4.5%, the economy will “outgrow” the debt. Imagine our debt to GDP down at 85% rather than today’s 102% debt to GDP ratio. That would be a pro-growth scenario for the nation.

Response

Markets like two things: certainty and cheap money. The interest rate you pay is the “price” of money. If the Committee’s projections of only two cuts are realized, then “higher for longer” rates are the theme. That means more expensive money. Consequently, bond and stock prices fell once Powell appeared to endorse the slower path to lower rates in his remarks. At the time of this writing the Dow Industrials were down 1.5%, or about 650 points.

Analysis

We have consistently stated this year that rates did not need to be cut. Gross Domestic Product growth at 2.5% (nominal 5.5%) is steady. We believe the housing market and, to an extent, industrial production have slogged through their own recessions thanks to the Fed elevating rates. Today’s cut may not help those sectors as most of their borrowing is 10 years and longer.

One theory: We have some indications from Powell and other FOMC members that the annual revisions of job growth last summer may have played into the Fed’s thinking. The Bureau of Labor Statistics revised job creation down by 818,000, a downward revision over four times the usual revision. Over the past 12 months, the BLS Household survey shows a drop of 1.2 million in private employment. If those numbers are accurate, then government deficit spending has covered over a lackluster economy. Perhaps the Fed is more worried about job creation than they are letting on.

Another theory from our September rate cut note: “Fully $15 trillion of our federal debt matures by the end of 2026. Its average interest rate is 2.6%. Two-year Treasury notes today are trading at 4.2%. Refinancing that $15 trillion today would raise its interest costs by roughly 60%, or about $240 billion. More borrowing is not the answer.”

Summary

Markets like lower borrowing costs. Forecasts for much of the stock market were based on 2025 having much lower borrowing rates. The Fed today threw cold water on those hopes, and traders are selling positions that benefit from lower rates. We do not believe yet that today’s selling marks a trend change; just a “hope” adjustment.

Please let us know how we can help you. 

Steve Orr is the Managing Director and Chief Investment Officer for Texas Capital Private Bank. Steve has earned the right to use the Chartered Financial Analyst and Chartered Market Technician designations. He holds a Bachelor of Arts in Economics from The University of Texas at Austin, a Master of Business Administration in Finance from Texas State University, and a Juris Doctor in Securities from St. Mary’s University School of Law. Follow him on Twitter here.  

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