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Federal Reserve Chairman Jay Powell sent his clearest signal yet on Wednesday that the U.S. central bank is finished with two years of tightening monetary policy and will begin cutting interest rates in 2024, bringing Wall Street's benchmark index closer to would drive a record high as investors celebrated the prospects of lower borrowing costs.
The Fed kept interest rates at a 22-year high, but the decision came with new forecasts from central bank officials pointing to 75 basis points worth of cuts next year – a more dovish rate outlook than previous forecasts.
Powell's comments after the Fed's decision also suggested a change in tone from the bank. The key interest rate is now “probably at or near its peak for this tightening cycle,” he said.
The Federal Open Market Committee's decision to keep interest rates at 5.25 to 5.5 percent was accompanied by the release of the Fed's so-called dot plot, which showed that most officials expected interest rates to rise next year would end at 4.5 to 4.75 percent.
Officials expect interest rates to fall even further in 2025, with most officials predicting they will end up between 3.5 percent and 3.75 percent.
Those forecasts for a steeper pace of interest rate cuts sparked a rally in U.S. stocks and a sharp fall in Treasury yields, with the two-year Treasury yield posting its biggest one-day decline since the Silicon Valley Bank collapse in March.
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The yield on two-year Treasury bonds, which changes with interest rate expectations, fell 0.3 percentage points to 4.43 percent after the Fed's announcement. The benchmark 10-year Treasury yield fell 0.17 percentage points on Wednesday and fell further in Asian morning trade to fall below 4 percent for the first time since August.
The benchmark S&P 500 gained 1.4 percent and closed at its highest level since January 2022.
“They went from a prolonged rise to talking about rate cuts in September,” said Priya Misra, portfolio manager at JPMorgan Asset Management. “They have been behind the curve on inflation, but perhaps they want to get ahead of the curve in terms of a slowdown.”
In a statement, the Fed explained the conditions under which it would “consider any additional monetary tightening that may be appropriate to return inflation to 2 percent over time” – a softer formulation suggesting that the central bank may not see the need to raise prices again.
Powell reiterated that the central bank was committed to being “cautious” in future interest rate decisions because economic growth is expected to slow and there has been “real progress” in tackling inflation.
He made that point, saying the Fed doesn't want to restrict the economy any longer than necessary.
“We recognize the danger of holding out too long,” Powell said, referring to waiting too long to cut rates. “We know this is a risk and we are very focused on not making this mistake.”
He later added that the Fed would not wait until inflation returned to 2 percent to begin cutting interest rates because “you would want to reduce constraints on the economy long before that point.” “You don't overshoot the mark.”
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The latest decision comes at a time when the Fed is trying to keep monetary policy tight enough to bring inflation back down to its 2 percent target without hurting the economy and causing too many job losses.
Some traders in futures markets had expected the Fed to begin cutting borrowing costs as early as March, although this week's inflation data and a solid jobs report on Friday fueled further bets that cuts would begin in May. Ahead of Wednesday's interest rate announcement, traders had been betting that interest rates could fall by more than a percentage point next year.
Fed officials' unemployment forecasts have changed little from September, with officials still expecting only a slight increase in the unemployment rate to 4.1 percent in 2024, from the current 3.7 percent.
However, estimates for core inflation, as measured by the personal consumption expenditure index, were cut slightly, with officials expecting an increase of 2.4 percent in 2024 and 2.2 percent in 2025. In September, median forecasts showed inflation of 2.6 percent in 2024 and 2.3 percent the following year.
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To consider cutting rates, the Fed must be confident that inflation will return to 2 percent on a sustained basis. If slower consumer price growth is accompanied by a sharp rise in unemployment, the reason for a cut would be clear.
The looming question is what happens if the economy continues as inflation falls. Some officials, such as New York Fed President John Williams and Fed Governor Christopher Waller, have suggested that monetary easing may still be necessary to keep interest rates from becoming too restrictive once adjusted for inflation Households and businesses will .
Additional reporting by Kate Duguid in New York