At its latest FOMC meeting, the U.S. Federal Reserve reduced its target range for the federal funds rate by 50 basis points, bringing it down to 4.75%-5%. This marked the first rate cut since March 2020. While the reduction was widely anticipated, some had speculated the Fed might opt for a smaller 25 basis point move. Along with the rate cut, the Fed updated its economic projections, signaling the potential for two additional 25 basis point reductions by year-end, totaling 100 basis points of easing in 2024, with a further 50 basis point cut expected in 2026. Meanwhile, the Bank of England held its interest rate steady at 5%.
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Market Reaction
Following the Fed’s announcement, the pound to U.S. dollar (GBP/USD) exchange rate surged past 1.33, its highest level since March 2022. The Bank of England’s decision to maintain rates also contributed to the pound’s strength. U.S. 10-year Treasury yields fell to 3.638%, and the S&P 500 rallied to 5,674.11. The market reaction reflects concerns that the Fed may be behind the curve in addressing economic conditions, especially with recent weak employment data and disappointing manufacturing PMI figures.
GBP/USD Exchange Rate Outlook
As the pace and trajectory of rate cuts in the U.S. appear to be moving faster than in the U.K., with the Federal Reserve reducing rates by 50 basis points and the Bank of England only cutting by 25 basis points in its previous meeting and keeping rates steady in its latest decision, we could see further strength in the pound against the U.S. dollar.
Looking ahead, the GBP/USD exchange rate is likely to remain above 1.30 for the foreseeable future. However, volatility is expected, influenced by key factors such as inflation and employment data, as well as significant events like the U.S. elections and the October budget, all of which could drive fluctuations in the exchange rate.
Future Expectations for Rate Cuts
The Fed’s decision to cut rates by 50 basis points sends a strong signal to the market that they have shifted their policy stance from restrictive to accommodative. This move reflects the Fed’s readiness to address concerns about weakening employment and contracting manufacturing PMIs. By cutting rates more aggressively, the Fed is showing its commitment to supporting the economy as it faces these headwinds.
During the press conference following the FOMC release, the Fed emphasised that they are not on a preset course and will continue to assess economic conditions on a meeting-by-meeting basis. This flexible approach highlights their intention to respond to evolving data rather than sticking to a predetermined path. According to the median forecast from committee members, the federal funds rate is expected to reach 4.4% by the end of 2024 and decline to 3.4% by the end of 2025, although further adjustments will depend on future economic indicators.
With two FOMC meetings remaining this year, further rate cuts are likely if inflation continues to moderate and leading economic indicators remain weak. The Fed’s shift signals a proactive approach to sustaining growth and addressing potential risks to the broader economy.
Could the U.S. Enter a Recession?
The possibility of a U.S. recession has been a growing concern as several key indicators point to economic weakness. Inflation projections were recently revised lower, with the Fed now expecting PCE inflation to hit 2.3% in 2024, down from the earlier forecast of 2.6%, and to decline further to 2.1% in 2025. Core inflation is also expected to decrease, reaching 2.6% in 2024 and 2.2% in 2025. At the same time, GDP growth for 2024 is now forecast at 2%, slightly down from the 2.1% estimate in June, and unemployment is projected to rise to 4.4% in both 2024 and 2025—higher than previously expected.
Recent data on employment and manufacturing add to concerns. Employment figures have shown signs of weakness, and manufacturing PMIs have fallen below 50, signaling contraction. A PMI below this threshold typically points to sluggish GDP growth and weaker inflation 12 to 18 months ahead. With both inflation and growth slowing, the Fed’s decision to start cutting rates now could help steer the economy away from a potential recession.
Although there were concerns that the Fed had been too restrictive for too long, by beginning rate cuts, they may be able to mitigate the risk of an economic downturn. While the Fed is somewhat behind the curve, the rate cut signals they are making efforts to catch up and support the economy. If they continue to reduce rates in response to further economic softening, it’s possible the U.S. could avoid a recession.
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