Rate Decisions by the Fed and Market Responses
Just a year ago this past Friday, the Federal Reserve increased its benchmark rate to its peak in 22 years.
This move — the 11th consecutive rate hike since early 2022 — was widely anticipated. Following this, the main question on the minds of all, from home purchasers to farmers to Wall Street investors, was whether an additional rate hike to suppress inflation was on the horizon.
During his press conference after the decision on July 26, 2023, Chairman Jerome Powell indicated that the central bank might raise its key rate from the updated level of 5.25% to 5.5%.
However, he later mentioned that the Fed might hold off on a rate increase during its next gathering in September.
When September arrived, the Fed indeed maintained its rate. It followed suit during its meeting on Oct. 31-Nov. 1, 2023.
Nevertheless, circumstances had shifted prior to the gathering. Interest rates began to climb again; the 10-year Treasury yield spiked to 5%, resulting in mortgage rates reaching 8%. Stock prices were declining.
Suddenly, towards the end of October, the 10-year yield hit a peak and started to drop. Traders had picked up on a sign: The Fed was preparing to lower rates. Stock prices began to recover.
Following the Fed’s meeting on December 17-18, Powell acknowledged that rates likely wouldn’t increase further. He now implied that the next adjustment would be a decrease.
Ecstatic investors transformed a solid rally into something monumental, helping companies like Nvidia, the producer of graphics processors vital for the advancement of artificial intelligence, become household names.
By the end of 2023, Nvidia shares had skyrocketed 230% to .52. (This price accounts for a 10-for-1 stock split on June 7.) Nvidia has risen 128% this year, even after a 19.7% correction post-June 20.
However, Powell didn’t specify when rates would decline. In fact, inflation remained stubbornly high, leading a few Fed officials to consider the possibility of rate increases this spring.
That was back in the spring.
If the Fed does not lower rates this week, it’s likely to do so in September, and during his press conference, following the Fed’s decision, Powell will outline several reasons for this initial rate cut, such as:
- Price inflation is approaching the Fed’s target of 2% annually.
- Bond yields are decreasing. So are mortgage rates, which are now around 6.8%.
- Housing market activity is still sluggish. New and existing home sales in June were below expectations.
- The once-strong job market has shown signs of weakening.
He may also point out that business bankruptcies have significantly risen compared to a year ago, with small enterprises being the most at risk.
Looking Ahead to the Next Rate Cut
So why delay any further?
It may be that Powell has required time to persuade the inflation hawks at the Fed to accept the decision.
This situation frustrates individuals close to the Fed, such as Bill Dudley, a former vice chairman. He believes the Fed should implement rate cuts immediately as any delays make a recession inevitable. His main concern, as highlighted in a July 24 column for Bloomberg, is this:
“Deteriorating labor markets create a self-perpetuating feedback loop. When jobs become scarce, households cut back on spending, resulting in an economic downturn, leading companies to reduce investments, which results in layoffs and further cuts in spending.”
Dudley is a veteran of the Fed. He had previously advocated for maintaining high rates until the appropriate moment to lower them. He believes that moment is now.
Consequently, discussions around rate cuts are prevalent. They will feature prominently on the Fed’s agenda during the two-day meeting commencing Tuesday.
If the Fed opts not to cut rates on Wednesday (commonly perceived as the likely outcome), Jerome Powell will definitely mention that the inflation landscape has significantly improved, with the odds of inflation resurgence dwindling.
And mark September 18 on your calendar as the date the Fed is expected to announce its first rate cut since March 2020, amidst the peak of the Covid-19 pandemic.
