Fed Watch - Fed cuts by 50 bps to orchestrate soft landing

The communication accompanying today's decision is clear: 'The US economy is in a good place, and our decision today is designed to keep it there.' In the policy statement, and during the press release, the upside risks to inflation, and downside risks to the labor market are referred to as balanced. The large step is a sign of their confidence that inflation will return to target. It is about getting rates closer to neutral, not about fighting an impending recession.

Powell provided more details on his assessment in the press conference. His confidence in inflation returning to target is broad-based, with only housing inflation 'dragging a bit.' As long as market rents do not see a new acceleration, they remain confident the shelter inflation component will come down. Wage growth is still a little bit above the level consistent with 2%, but pressures are waning as the labor market cools. Powell carefully balanced his description of the labor market, steering observers away from the thought that this strong initial cut is a reaction to expected economic weakening. He gave several arguments on how the overall state of the labor market is still solid. Indeed, his reading of the labor market is not about the level, but on the trend. As upside risks to inflation have come down, the downside risks to employment have increased.Despite repeatedly describing these two risks as balanced, the confidence in inflation coming down, did seem greater than the confidence that unemployment would not increase more than the newly projected 4.4%. For example, he noted that the Beveridge curve, which plots the vacancy rate to the unemployment rate, might now be in the horizontal part, where declines in job openings lead to increases in the unemployment rate. He also referred to the weakness in non-farm payrolls and the negative revisions based on QCEW data.

The Fed eased more quickly today than we had anticipated, meaning our projected policy rate path should be re-evaluated. Our assessment is that this initial cut was large to make progress towards neutral. Indeed, Powell all but admitted that this was a catch-up for the lack of easing in July, stating they would have likely cut in July had they had the labor market report that released two days later. We therefore see this 50bps cut as a one-off. This is also consistent with the new dot plot where the median members pencils in another 50bps by year end. We therefore continue to expect 25bps cuts in each meeting going forward, but now at a 25bps lower level, with the upper bound of the fed funds rate expected to fall to 4.50% by year end, and reaching neutral (3.00%) by September next year.