INSIGHTS

September 12, 2024

Q & Amy

Edition 13

Angus: A change in monetary policy is on the horizon. Can you explain the process? When do you expect the Fed to start reducing interest rates?

Amy: The Fed prizes predictability and prefers to telegraph their intentions to avoid causing volatility in investment markets. Using an approach refined over decades, Fed officials utilize speeches, written communications, and press conferences to guide investors and citizens along the path of monetary policy adjustment.

In his speech at the annual Jackson Hole Economic Symposium held on August 22–24, Fed chairman Jerome Powell made clear that the Fed does not want any additional softening in the labor market and that movement toward more accommodative policy has finally arrived. Powell noted that the risks in the economy have shifted from inflation to growth. The next scheduled Fed meeting is September 17–18, when the Federal Open Market Committee (FOMC) members are expected to start reducing the federal funds rate.

Amy Bush, CFA

Chief Investment Officer

C. Angus Schaal, CFP^®

Senior Managing Director

Angus: How does the Fed determine how much and how quickly rates should be reduced?

Amy: Traditionally, when the Fed eases policy during times free from excessive economic or financial stress—as is the case today—it proceeds gradually, cutting interest rates in 0.25% increments over many months, usually at scheduled meetings. But they can also act between meetings in times of stress. The market expects the Fed to act at each of the remaining 2024 meetings in September, November, and December.

Some economists believe the Fed will adhere to convention and cut the current federal funds rate of 5.50% by a quarter point next week. Others, however, fear that the Fed has already delayed easing too long and expect a 0.50% cut. Ultimately, the FOMC is trying to achieve a “neutral” level of rates— one that is neither restrictive nor accommodative. Estimates of the “neutral” target range from 2.5% to 4%. The wide range indicates the Fed’s difficult job in achieving equilibrium.

The health of the labor market will dictate the Fed’s urgency. At 4.2%, the U.S. unemployment rate is above its cycle low of 3.5%. However, the prime age (25–54) labor participation rate at 83.9% is the highest it’s been since the late ‘90s. The economy is widely considered to be in the vicinity of maximum employment. Job growth has slowed, and in more cyclical portions of the economy (payrolls minus government, health care and education jobs) the economy is losing jobs.

Angus: How can an investment manager respond to rate cuts?

Amy: Every cycle is different and driven by unique factors, so investment managers are mostly concerned with the overall trend in rates, as opposed to trying to react to each single rate change.

Angus: We have included a chart below to illustrate the past three monetary cycles. Note the size of the steps (size of rate change) in the current cycle compared to the past.

Amy: You can see in 2023 the Fed was caught off guard by surging inflation and had to implement multiple 0.75% increases, creating a tough environment for bond investors. While we do not expect rates to fall back to zero, we look forward to a better backdrop for our bond ETFs.

Fed Funds Rate

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