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Last Wednesday, the U.S. Federal Reserve (Fed) implemented a notable change during the September 2024 meeting of the Federal Open Market Committee (FOMC), the Fed arm responsible for U.S. monetary policy. The FOMC decided to reduce the Federal Funds rate by 50 basis points (0.50%), lowering the target range to 4.75%–5.00% (Reuters, 2024). This is a significant shift, as the rate had remained between 5.25% and 5.50%, with an effective rate of 5.33%, since July 2023.
This action represents the most substantial rate cut by the Fed, outside of emergency measures such as those during the COVID-19 recession, since the global financial crisis of 2008. Some market observers argue that this cut was overdue, pointing to indicators such as the weak July 2024 employment report, which reflected a cooling labor market. However, others caution that the cut may be too aggressive and could risk reigniting inflationary pressures that the Fed has been combating since 2022.
Fed Chair Jerome Powell emphasized that the rate reduction was not a reactive measure but a proactive step in anticipation of economic conditions, with expectations for additional, smaller cuts through the end of 2024. This raises questions as to why the rate cut occurred now rather than earlier in the year and what implications it may have on farmers. We’ll discuss that in today’s newsletter.
Why Cut The Rate Now?
As mentioned in a previous Morning Coffee & Ag Markets newsletter, The Federal Funds rate is the cost of borrowing between banks overnight. Banks have deposit requirements and must maintain those reserves by borrowing money from other banks. An increase in the Federal Funds rate raises the cost of these interbank loans, which subsequently raises the prime lending rate, impacting the cost of borrowing for individuals and businesses.
The Fed adjusts the Federal Funds rate to manage inflation and economic activity. When inflationary pressures arise, the Fed raises the rate to make borrowing more expensive, promoting slower economic growth. Conversely, during periods of economic downturn, the Fed lowers the rate to encourage borrowing and stimulate investment. The concept is designed to balance economic activity, either by promoting growth through cheaper borrowing or by tempering inflation through more costly credit.
Why did the Fed decide to cut the rate now? Well, one of the central objectives of the Fed is to restore price stability without triggering a substantial increase in unemployment. Fed Chair Jerome Powell has expressed confidence in the current unemployment rate, which stands at a "healthy" 4.2% (Figure 1), a level that has remained relatively stable over time. During his press conference on Wednesday, Powell noted that "maintaining an unemployment rate in the low 4% range reflects a healthy labor market" (CNBC, 2024).
An increase in unemployment signals to the Fed that the labor market is weakening, a potential consequence of maintaining persistently high interest rates. Without a rate reduction, the risk of slowing the economy too sharply could lead to higher unemployment, without achieving the desired stabilization of prices. The rate cut is intended to mitigate this risk.
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