- FOMC cut the Fed Fund rate by 25 bps at September meeting; two more cuts are expected this year
- Stark inconsistencies are evident when one compares the economic projections with Fedspeak
- The cutting of rates whilst upgrading economic projections highlights deep divisions within the FOMC
Labour vs Inflation Concerns: Sharp divisions in clear sight. The Federal Open Market Committee (FOMC) has, as expected, cut the Fed Fund rate by 25 bps at the September meeting. Based on the dot-plot, two more cuts are expected this year (up from one cut). Given the unprecedented political distractions surrounding the attempted ouster of Lisa Cook and appointment of Stephen Miran, the decision to cut by quarter basis point (as opposed to a larger cut) represents a victory for the embattled Fed Chair Powell, who in his press conference has made clear that inflation risks remain tilted to the upside and that policy is not on a preset course.
But stark inconsistencies are evident when one compares the economic projections with what Powell said in the news conference, for instance:
- Powell mentioned growing “downside risks to employment” in the press conference and yet, the GDP growth estimates for 2025 and 2026 have been revised up while the unemployment rate for 2026 and 2027 have been revised down.
- Economic projections are showing higher inflation risks for 2026 and yet, it is also forecasting more rate cuts ahead.
The mere act of cutting rates while concurrently upgrading economic and employment projections highlights the deep divisions amongst policymakers in the FOMC. This situation will likely get messier next year as potential changes in committee personnel takes hold.
Fed inflation target: Still viable? The Fed has a long-held inflation target of 2%. But with the central bank cutting rates now when: (a) core PCE inflation is at 2.9% and (b) there is no US recession in sight, the next natural thing to ask is: Does the Fed inflation target still matter? Indeed, given limited clarity on the full downstream impact of the tariff war and OBBBA, the Fed’s enthusiasm in cutting rates runs the risk of committing a major policy error further down the road. Perhaps, the Fed may have decided that labour market concerns supersede inflation concerns at this juncture. But as the central bank’s economic projections data shows, these concerns are separated by a fine line and the narrative will evolve in tandem with changes in incoming macro data.
Fed rate cuts in non-recessionary environment: Melt-up for risk assets. The start of a Fed rate cutting cycle has historically preceded major recessions. Since 1986, there have been four such instances. For example, the burst of the dot-com bubble saw the Fed cutting rates by 550 bps over a period of 30 months as a recession hit in Feb 2001. Thereafter, the Fed again cut rates aggressively during the subprime crisis as the economy fell into a downward spiral. During these occasions, the S&P 500 registered average declines of 3% in the subsequent 12 months.
There was, however, one occasion where Fed easing was not followed by a recession and this took place in 1995. After the initial rate cut, the S&P 500 registered gains of c.13.9% in the subsequent 12 months as the arrival of the Internet started a new industrial revolution and drove economic activities higher. Given strong AI-related capex in the current market, we believe that today’s environment mirrors that of 1995 and this augurs well for the resilience of risk assets.
Policy and macro uncertainties abound: Portfolio diversification is key. The trajectory of Fed policy will be highly dependent on incoming macro data and the potential impact from the tariff war remains a major wild card. Adopt a two-pronged approach in your portfolio construction: (a) ride the Fed policy easing wave with cyclicals like US Tech and EM assets like North Asia equities, and (b) hedge policy uncertainties with alternatives like gold, hedge funds, and private assets.
Figure 1: Labour market concerns outweigh inflation concerns slightly
Source: Bloomberg, DBS
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