Fed Cuts! Market (Rightfully) Yawns

They did it! As near-universally expected, the Fed just cut its fed-funds target range by a quarter percentage point, bringing it down to 4.00% - 4.25%, the fourth cut in this “cycle” after a nine month pause. Most observers either highlighted the oddity of this meeting’s particulars or saw the move as critical for stocks and the US economy. Folks, some news: While this cut is fine and dandy—we don’t object to it at all—the effects are far smaller than most tout. Let us explain.

Yes, this latest cut does bring the full cycle’s (if something on hold for nine months can still be considered a cycle) to 1.25 percentage points. And traders are penciling in two more by yearend. Maybe those happen! Maybe there will be more! The Fed’s generally useless dot plot of future rates matches traders’ expectations for two more 2025 cuts, and the median look-ahead is for a couple more by yearend 2026. But today’s rates are already where the Fed projected in June and December, according to the central tendency in those forecasts. And consider 2022: Fed forward guidance early that year argued for no hikes and looking through “transitory” inflation pressures. As you likely know, that misguidance didn’t hold—the Fed embarked on a steep hike cycle soon thereafter.

So you can’t really know what the Fed will do from here. They are people, swayed by biased interpretations of incoming data. And that was true well before the odd optics around this meeting emerged, which saw one Fed Governor (Lisa Cook) attend a meeting the Trump administration tried to bar her from while the president’s temporary nominee (Stephen Miran) rushed to join via appointment to an unrelated opening. Pundits were already handwringing over dissention and a lack of uniformity at July’s meeting. But is groupthink really preferable to a diversity of opinions? We don’t think so. And, unsurprisingly, there was less dissent at this meeting than July’s—one board member (Miran) wanted to cut by 0.50 percentage point. That was it.

Still, some claim the present scenario is more than mere differences in opinions, given President Trump’s vocal criticism of Fed Chair Jerome Powell and his effort to fire Cook for cause, noting this risks the Fed’s independence. We won’t rehash all our thoughts on that here—and there is no need to today. There is little reason to see a 0.25 percentage point cut through a political lens. The Fed had ample reasons to cut rates today.

One, the Humphrey-Hawkins Act slaps a dual mandate on the Fed to base policy on the sketchy guidelines of maximum employment and price stability. With the targeted inflation rate (the headline personal consumption expenditures price index) running at 2.6% y/y in July and in a range of 2.2% to 2.6% since March, the inflation war is over.^[i] Yes, this is above the 2% target. But no central bank has ever proven the ability to fine tune anything important to the decimal point. While prices have cooled, hiring has too. So on that basis, a cut could be justified under the Fed’s mandate.

Two, a cut could bullishly widen the US and global yield curve spreads—the gap between short and long rates. Since banks borrow short term to fund longer-term loans, a wider spread means more profitable lending. That motivates banks to extend credit, juicing growth. This is why steep curves are traditionally seen as bullish indicators of future economic expansion. The US curve spread was miniscule before the Fed’s cut. The ECB’s eight rate cuts in Europe have steepened its curve notably, with spreads far wider than America’s. Fed cuts could push it in that direction some.

So a cut or three could be fine and good. But they aren’t needed either. There is little sign in data of contraction underway. The much-ballyhooed revision to jobs data still shows positive payroll growth, even if the average has slowed. August retail and industrial data both proved resilient, despite tariffs taking hold that month. The month’s Institute for Supply Management (ISM) Services purchasing managers’ index (PMI) hit 55—well above the 50 mark that divides expansion from contraction—with forward-looking new orders at 56.^[ii] ISM’s Manufacturing PMI did contract in August, at 48.7.^[iii] But this merely extends a long-running trend. More notable: Manufacturing new orders improved to 51.4—the first expansionary read since January and one of only five in the last two years.^[iv] Only time will tell if this single read is a trend, but there is little to suggest big, new trouble here—nothing that screams America needs lower policy rates to stave off calamity.

Those cuts also aren’t a gamechanger for stocks. As we wrote in August, rate cuts rarely shift the direction of markets materially going forward, with the prevailing trend largely continuing. In 2008, the Fed’s vast rate cuts and quantitative easing didn’t end the financial crisis-driven bear market. In 2001, rate cuts did nothing to stop a bear market that ran through October 2002. The same holds for hikes.

Nor do these rate cuts automatically mean you are likely to see lower mortgage rates or long bond yields. That could happen but it isn’t assured. The Fed only sets short rates, while the market sets longer-term ones. Consider: When the Fed cut by 50 basis points last September, 10- and 30-year Treasury yields were at 3.70% and 4.03%, respectively.^[v] Now the two are at 4.04% and 4.65%—higher, despite more Fed cuts in the interim.^[vi] The same has happened in Europe, where eight ECB cuts haven’t meant lower long yields. Perhaps long rates do follow short ones down. But, again, it isn’t assured.

For all the drama in headlines before the announcement, the S&P 500 barely budged, finishing the day down -0.1%, paralleling a minor dip earlier in the trading day.^[vii] That teensy reaction seems apropos to us. Markets, after all, pre-price widely expected events—and this cut was just that. But even looking forward, we think it would be a mistake to hinge your market views on whatever the Fed does. Always remember: Interest rates matter, but they aren’t all-important.