Federal Reserve’s Path to Neutrality: Second Consecutive Rate Cut

On November 7th, during the latest FOMC meeting, the Federal Reserve announced a second consecutive interest rate cut, reducing the target range by 25 basis points to 4.5% - 4.75%, following a 50 basis point cut in September. This decision aligns with recent economic data showing resilience, as reflected in inflation and GDP growth indicators that exceeded expectations. During the accompanying press conference, FED Chair Jerome Powell described the policy trajectory as moving toward neutrality.

In September, the Consumer Price Index (CPI) rose by 0.2% month-over-month for the third consecutive month, with the annual inflation rate adjusting slightly to 2.4% from 2.5%. Core CPI, which excludes food and energy, increased by 0.3% in September, with the year-over-year rate moving from 3.2% to 3.3%. Approximately 80% of core CPI reflects non-housing goods, which have largely returned to pre-pandemic levels when inflation was around 2%. Currently, core CPI is primarily influenced by housing services due to a lag effect in lease renewals. New leases are reflecting lower inflation, aligning with present market conditions; however, older leases with previously higher rates are still a factor in the current data. As these older leases update, core CPI is expected to show a gradual easing in inflationary pressure. A similar lag is observed in the insurance sector, where delayed adjustments continue to impact inflation measurements.

Real GDP grew by 2.8% in the third quarter, consistent with the second quarter and above expectations. Consumer spending and investment in equipment and tangible assets have shown resilience as supply conditions gradually stabilize. However, housing market activity remains weak, and job growth has slowed, with the unemployment rate now at 4.1%. Although this rate has increased compared to the previous year, it remains at a historically low level. The labor market is less constrained than in 2019 pre-pandemic, with limited impact on inflation.

The U.S. economy continues to demonstrate resilience, outperforming general expectations. Given this strength, the Federal Reserve does not feel immediate pressure to reduce interest rates. Powell emphasized that future rate decisions will be made on a meeting-by-meeting basis, informed by incoming economic data. He described the policy objective as moving gradually toward a "path to neutrality," with a balanced and data-driven approach.

Following the press release, market expectations regarding the economic outlook have remained largely unchanged. The World Interest Rate Probability (WIRP) indicator currently suggests that market participants see a 56% probability of an additional rate cut in December, with a general expectation that rate reductions will continue gradually throughout 2025.

World Interest Rate Probability (source: Bloomberg) November 7th, 2024

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