Historic period for the Fed
The Federal Reserve has a dual mandate to achieve maximum employment and keep prices stable. In other words, the central bank’s objective is to minimize inflation and maximize employment across the economy.
The Federal Open Market Committee in its statement last month said it has “gained greater confidence that inflation is moving sustainably toward 2%, and judges that the risks to achieving its employment and inflation goals are roughly in balance.”
When inflation flared up in the aftermath of the pandemic, the Fed started raising interest rates. From March 2022 to July 2023, the central bank raised interest rates 11 times to bring it to a range of 5.25% to 5.5% — the fastest pace in 40 years. Not only was this historic rate-hiking cycle conducted during the Biden administration, but it also began just a few months away from the 2022 midterm elections.
Powell’s mention of a lag during the press conference is based on an economic theory put forth by economist Milton Friedman that says that after changes in monetary policy there’s usually long and variable lags in measures like inflation, employment or output also showing changes.
With this in mind, investors should be looking ahead to next year to understand the impact of the Fed’s rate cut decision.
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Learn MoreLong-term impacts
Economists expect several more rate cuts ahead. For instance, Morgan Stanley’s Global Investment Committee believes the benchmark rate will fall to 3.5% by the end of 2025.
For consumers, this could be good news. Lower rates could make it cheaper to apply for a new mortgage or car loan or refinance an existing line of credit next year.
Rate cuts could also be a boon to investors. “Since 1980, five of the 10 best years for the S&P 500 happened when the Fed was cutting rates without a recession (1985, 1989, 1995, 1998, 2019),” according to JPMorgan. “The Fed has cut rates 12 times when the S&P 500 was within 1% of its all-time high. The market was higher one year later all 12 times (with a median return of 15%).”
Of course, rate cuts have the opposite effect on fixed income products such as high-yield savings accounts and certificates of deposits. Savers and investors should plan for this shift accordingly.
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