Fed Unlikely to Cut Rates Early, Experts Say

It is highly unlikely that the Federal Reserve will take the rare step of lowering interest rates between its scheduled meetings, according to Bank of America’s top U.S. economist. This assessment comes in response to calls for immediate rate cuts following Friday’s disappointing jobs report and a stock market decline that undermined confidence in the U.S. economy’s direction.

Some experts, including University of Pennsylvania professor Jeremy Siegel, have suggested that the Fed should consider lowering rates—a measure typically used to stimulate economic growth—before its September 17-18 meeting. They argue that such a move could address concerns about the weakening perception of the economy. Interest-rate futures traders have even assigned up to a 60% probability of a rate cut this week. However, calls for an immediate Fed response have diminished as the stock market began to recover some of its losses on Tuesday.

Despite these calls, current conditions do not meet the historical criteria for an intermeeting rate cut, according to Bank of America’s Michael Gapen. In a report to clients on Tuesday, Gapen emphasized that historical precedents suggest today’s situation is far from warranting such drastic action.

The Fed’s Open Markets Committee votes on the target federal funds rate at its ten regularly scheduled annual meetings. However, it does have the authority to make changes between these meetings if deemed necessary. Gapen pointed out that previous intermeeting cuts have occurred only under “truly emergency conditions” in the economy or financial markets. He examined seven such cuts since the early 2000s, including two during the onset of the COVID-19 pandemic, two during the 2008 financial crisis, one immediately following the September 11 attacks, and two during the 2001 technology stock crash when the Nasdaq Composite index plummeted 70% over 15 months.

“The bar for intermeeting cuts is extremely high, and current conditions do not warrant such action,” Gapen stated. He noted that historical examples suggest today’s circumstances are “not even close” to justifying an emergency rate cut.

Although economic growth is slowing, the U.S. has just experienced its 43rd consecutive month of strong labor growth. July’s unemployment rate of 4.3%, the highest in nearly three years, remains lower than the average unemployment rate from 2008 to 2016. Additionally, the stock market decline, even before Tuesday’s recovery, was not unusually severe. The S&P 500 was only 8.5% below its all-time high on July 16, falling short of a 10% correction. Historically, the S&P 500 enters correction territory once a year on average, a pattern observed since the 1930s, according to Bank of America strategist Savita Subramanian.

The Federal Reserve operates under a dual mandate: to control inflation and maximize employment. Some analysts believe that maintaining interest rates at a two-decade high of over 5% for the past 12 months—despite cooling inflation—may have hindered labor market expansion. While rate cuts generally boost stock prices by improving companies’ profit margins through lower borrowing costs and increasing consumer spending, there is concern that an intermeeting rate cut might signal panic from the Fed, potentially causing further market turmoil.

Although it is unlikely that the Fed will cut rates in the coming weeks, the market still anticipates significant action from the central bank at its September meeting. Federal funds rate futures contract trades currently imply a 100% probability of a rate cut next month, with a 66% chance of a 50 basis-point cut and a 34% chance of a 25 basis-point cut, according to the CME FedWatch Tool. The Fed has not reduced rates by 50 basis points at a regular meeting since 2008.

25% is the probability, as estimated by Goldman Sachs economists led by David Mericle, that the U.S. will enter a recession within the next 12 months. While this is an increase from Goldman’s estimate of 15%, the risks of a significant downturn are considered “limited,” given that economic data remains “fine overall” and the Fed still has 525 basis points worth of rate cuts available if needed.