Dovish Fed contemplates rate cuts: risks to weaker US growth persist

The Fed kept its benchmark overnight borrowing federal funds rate unchanged at 5.25-5.50% for the third consecutive meeting, that is, a period now spanning almost five months. The FOMC statement and press conference were more dovish than we – and the market – expected. This was exemplified in Chair Jerome Powell’s comment that the Fed believes interest rates are at or near their peak in this cycle.

  • Fed action: The Federal Reserve kept its benchmark federal funds rate unchanged at 5.25-5.50% for the third consecutive meeting. Chair Jerome Powell struck a more dovish than expected tone, noting that interest rates are at or near their peak. Updated forecasts of future federal funds rates included an additional 25 basis point rate cut next year. The Summary of Economic Projections (SEP) also saw a notable downgrade to the core personal consumption expenditures (PCE) inflation forecast.
  • FOMC statement: The Federal Open Market Committee (FOMC) acknowledged that economic activity slowed in Q3, and while progress has been made in tackling price rises, inflation remains elevated. However, the Fed’s forward guidance was also tweaked to align with the SEP, which reflects the possibility of three more 25bp rate cuts in 2024.
  • Market reaction: Markets reacted positively to the Fed’s monetary policy decision, with government bonds and equities rallying sharply. The US yield curve steepened on the prospect of easier monetary policy, as yields declined more on shorter than longer-dated maturities, and major US equity indices closed approximately 1.4% higher. By contrast, the US dollar depreciated by nearly 1%, and remains vulnerable to the start of the Fed’s easing cycle.
  • Investment implications: The Fed may be preparing to cut rates, but remains data dependent. Despite its desire for a ‘soft landing’, there are still risks to US growth. We remain cautious, and favour themes of longer interest rate duration, higher credit quality, and exposure to sectors where spreads compensate for potential macroeconomic uncertainty and tighter market liquidity.

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