Will the Fed Take a Cautious Approach or Make a Bold Move in Its First Rate Cut Since 2020?
The Federal Reserve is preparing to cut interest rates at its upcoming meeting on September 17-18. The big question isn’t whether they’ll cut rates – that’s almost certain – but how much. Will it be a modest 0.25 percentage point cut, or a larger 0.5 point cut?
Federal Reserve Chair Jerome Powell faces a tricky decision. The Fed is cutting rates for the first time since 2020, and officials are confident they’ll need multiple rate cuts over the coming months. But should they start with a small cut to see how the economy reacts, or go bigger from the start?
Powell recently spoke at a meeting in Jackson Hole, Wyoming, where he emphasized that the direction of future cuts depends on economic data and how risks evolve. The Fed had raised interest rates to 5.3%, the highest in two decades, to combat inflation. But now, inflation is cooling, and there are concerns that keeping rates too high for too long could harm the job market.
Mixed Economic Signals
Recent data is giving the Fed mixed signals. Housing costs are rising, but inflation in other areas is easing. Job growth has slowed, but layoffs remain low. While some analysts believe a smaller cut is more likely, others argue that the Fed may need to move faster to avoid a more significant slowdown in the economy.
The Fed has three meetings left this year – September, November, and December – and the decisions made at next week’s meeting could set the tone for the rest of the year.
The Case for a Smaller Cut
The Fed usually prefers smaller rate cuts of 0.25 points because it allows more time to study how the economy is responding. Starting small would signal that the economy is stable and that no drastic measures are needed. A small cut could also prevent markets from expecting rapid cuts, which could create market rallies and make inflation harder to control.
On the other hand, some officials believe that starting with a larger cut could provide a safety net in case the economy slows down faster than expected. Inflation is already falling, and real interest rates (adjusted for inflation) are at their highest levels in years. A bigger cut could help lower rates closer to a neutral level, where they neither stimulate nor slow down the economy.
The Fed must carefully balance the need to reduce inflation without stalling job growth. While a 50-point cut might seem aggressive, some officials argue that it could be justified to ensure the economy remains on track. However, many believe starting with a smaller cut offers more flexibility and is easier to communicate to the public and markets.
In the end, the Fed’s decision will come down to how it views the risks. Is inflation the bigger concern, or is the slowing job market the priority? The answer to this question will shape the size of the rate cut – and the outlook for the U.S. economy.
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