Expected for over a year, the U.S. central bank has now officially decided to pivot its monetary policy towards a less restrictive cycle. Since Jerome Powell’s speech at the Jackson Hole symposium at the end of August, it had been clear that the Fed would act at the September FOMC meeting, but the extent of the rate cut was still uncertain. Right up to the end, the outcome was still unpredictable, with forecasts swinging back and forth between a 25 bps cut and a 50 bps cut. As we mentioned in our last issue, while the Fed basically had sufficient room to maneuver to begin its rate cuts with a 50-bp jumbo cut, there was nevertheless a risk that the Fed might appear to be overreacting to the economic slowdown. This was clearly not the case, and Fed Chairman Jerome Powell was reassuring at the press conference.
In detail, despite the usual precautions, FOMC members seem to be considering inflation less and less as a problem. In fact, forecasts for this year and next have been revised downwards for both headline and core inflation. On the latter, which is still mainly impacted by the rent component, Jerome Powell considers that the downward trend is set to continue. Rather counter-intuitively, the cut in key rates could even accentuate the trend. The housing market is still completely frozen at high rates, while most American households have taken out much lower fixed-rate mortgages. The Fed’s action could therefore bring some fluidity back to this market.
With inflation no longer an issue, the FOMC can focus on the second part of its mandate: the labor market. Although he reiterated that the US economy is solid, Jerome Powell does not want to take any risks, and therefore sees this “jumbo cut” in rates as “insurance” and “a sign of the commitment” of the Fed to ensuring solid growth, especially since the labor market is no longer a source of inflation.
What’s next? Jerome Powell seems to have achieved the improbable: inflation is heading back towards its target, growth for the next two years is expected to be 2% (close to potential growth) and the dot plots forecast a return to a neutral rate by 2026. Investor expectations are not far from these levels, and the soft landing scenario is so consensual that markets have reacted relatively little to this rate cut. So all is well in the best of all possible worlds. In this scenario, long yields seem to us to be relatively well priced, and we are still waiting for an adjustment on the short end of the curve to restore some of their steepening. As for equities, while the Magnificent 7 are artificially pushing up valuations, the return of the Fed Put should enable the rest of the market to catch up.
