Lower Rates Accelerate Rally

The Federal Reserve acted as expected this week, lowering the target Fed Funds rate by 0.25% to 4.25%. The Fed also signaled that two additional quarter-point rate cuts are likely by the end of the year, which was not as widely expected. The news pushed the stock market to new record highs. S&P 500 passed the 6,600 mark and the Dow climbed above 46,300 for the first time. Meanwhile, mortgage interest rates fell to 6.35%, their lowest level in a year.

Job market data released in September have been weak, with the unemployment rate rising to 4.3%, giving the Fed concern for the job market and a reason to be more aggressive in lowering interest rates. The Fed’s post-meeting statement noted that “jobs gains have slowed” and that “downside risks to employment have risen”.

Meanwhile, inflation remains at 2.9%, still above the Fed’s stated 2% guidance. Cutting rates too quickly risks stoking inflation, while cutting rates too slowly risks a recession. For now, the market appears to be pricing-in 2 additional rate cuts between now and the end of the year. However, Fed officials emphasized that future rate cuts would depend on incoming economic data, particularly inflation and labor market trends.

It was notable that there was a significant divergence of views among the voting members of the Federal Open Market Committee. While the majority of the members supported continued easing, open participant reportedly did not want any cuts, and another supported a larger 0.5% cut immediately and 1.25% in cuts by the end of the year. The divergence of views is reflective of the dynamic economic environment, where GDP growth remains strong at the same time that labor markets are showing signs of weakness.

Once again it is likely that markets will watch inflation and labor data in the coming months to confirm market expectations for 2 additional rate cuts before the end of the year.