The US Federal Reserve cut its benchmark interest rate by 50 basis points on Wednesday, reducing it to a range of 4.75 per cent to 5.00 per cent. This marks the first rate reduction in four years and signals a notable shift in the central bank’s approach to managing inflation and economic growth.
The decision has left both markets and analysts assessing the broader implications for the US and global economies, with various currencies, commodities, and sectors responding in different ways.
What is the reason behind the cut?
The Fed’s decision to slash rates is largely driven by confidence that inflation is continuing its downward trajectory toward the central bank’s long-term goal of 2 per cent. After months of aggressive rate hikes aimed at taming inflation, which peaked at 9.1 per cent in June 2022, inflation has now eased to 2.5 per cent as of August 2024.
This decline has prompted the Fed to shift its focus toward ensuring sustained economic growth and job stability. Fed Chair Jerome Powell, during his press conference, stated, “You see growth at a solid rate, you see inflation coming down, and you see a labour market that’s still at very solid levels.”
Powell also dismissed concerns of an imminent recession, saying, “I don’t see anything in the economy right now that suggests the likelihood of a recession.” Nevertheless, the rate cut comes amid a backdrop of cooling employment data.
Unemployment in the US, which had reached historic lows during the height of inflation, has risen to 4 per cent for the first time since January 2022.
How did global markets react?
Global markets responded swiftly to the Fed’s announcement. Initially, the US dollar weakened as traders digested the impact of the unexpected 50 bps cut. The dollar index dipped to its lowest point since July 2023 at 100.21 before recovering slightly, closing at 100.970, up 0.05 per cent on the day.
Major currencies reacted accordingly, with the euro dropping 0.01 per cent to $1.111275, and the Japanese yen remaining flat at 142.370 per dollar. Vassili Serebriakov, an FX & macro strategist at UBS, told Reuters, “It’s a more dovish cut. It certainly wasn’t a hawkish cut… a 50-basis point cut is unambiguously dollar negative.”
Commodities also saw notable shifts, particularly gold. Spot gold prices, which had reached a record high of $2,599.92 per ounce following the Fed’s announcement, stabilised at $2,562.85 on Thursday morning. This movement reflects market confidence in gold as a safe-haven asset amidst monetary easing.
Meanwhile, the Indian rupee appreciated to one of its strongest levels in six weeks. The rupee was at 83.66 against the US dollar as of 10:20 am IST, up 0.1 per cent compared to its close at 83.75 in the previous session. Despite this rally, traders believe that importer dollar bids will limit further gains for the rupee.
Amit Pabari, Managing Director at CR Forex, commented, “All eyes will be on the Reserve Bank of India’s response and whether the rupee can maintain its upward trajectory.”
In the US, stock markets hit record highs on Monday and Tuesday, anticipating the Fed’s rate cut. Historically, lower interest rates tend to support stock prices as companies can borrow more cheaply to invest in growth, and investors often shift away from bonds and savings accounts to seek higher returns in equities.
What does this announcement mean for you?
For consumers, the effects of the rate cut will take time to filter through the economy. “The adjustment for consumers in general is less instantaneous than something like market prices,” Anastassia Fedyk, assistant professor of finance at UC Berkeley told UK’s The Guardian.
Mortgage rates, which peaked at 7.79 per cent in 2023, have already begun to decline, now hovering below 6.5 per cent. However, mortgage borrowers and homebuyers should expect gradual relief. Fedyk added, “For existing mortgages, unless people are going to refinance, that’s not going to have an immediate effect.”
Other forms of credit, such as auto loans and credit cards, will also see marginal declines. Auto loan rates, in particular, are closely tied to the Fed’s interest rate movements, though other factors like an individual’s credit score and the type of vehicle also play a role in determining loan terms.
Credit card debt, while expected to become slightly cheaper, remains one of the more expensive forms of debt for consumers.
What could be the global impact?
The Fed’s rate cut won’t just impact the US, its ripple effects will be felt globally. Countries like Hong Kong and Gulf states, whose currencies are pegged to the dollar, will likely follow suit with their own rate adjustments.
This could lower borrowing costs for businesses and consumers in those regions. Additionally, a weaker dollar could benefit US exporters by making American goods cheaper on international markets.
The decision also comes as many global central banks, including those in Europe, the UK, Canada, and New Zealand, have already embarked on rate-cutting paths.
For many international investors, particularly those with stakes in the US stock market, the Fed’s move is seen as positive. Lower interest rates generally boost equity prices, as borrowing costs for corporations fall, encouraging investment and expansion.
However, some economists warn that despite the Fed’s optimism, there are still risks of a global economic slowdown. A closely watched indicator, the US Treasury yield curve, which measures the gap between yields on two- and ten-year Treasury notes, reached its steepest level since July 2022 after the Fed’s cut, signaling potential concerns about future growth prospects.
Brad Bechtel, global head of FX at Jefferies, remarked, “Clearly the Fed is trying to get out in front of the slowdown in the US economy and provide support. But so far, the reaction in the market isn’t overly crazy.”
Are more rate cuts to come?
The Fed’s rate reduction may only be the first in a series of cuts, with policymakers signalling the possibility of further easing.
Projections show that the Fed’s benchmark rate could fall by another 50 basis points by the end of 2024, followed by a full percentage point cut in 2025, and an additional half percentage point reduction in 2026, eventually stabilising at a range of 2.75 per cent to 3.00 per cent.
Futures on the Fed funds rate are already pricing in another 70 basis points worth of cuts this year.
Powell has reiterated that the Fed will continue to be data-driven, ensuring that inflation remains under control while safeguarding the labour market. He stated, “The time has come for policy to adjust. The direction of travel is clear.”
Any misstep in the Fed’s approach could exacerbate fears of a US recession, with significant consequences for global markets and economies.
With inputs from agencies
