The US Federal Reserve cut the bellwether federal fed funds rate by 50 basis points as it attempts to sustain a soft landing for the US economy despite continuing inflationary pressure. The federal funds rate is now set at 4.75-5.0%

"This decision reflects our growing confidence that with an appropriate recalibration in our policy stance, strength in the labour market can be maintained in the context of moderate growth and inflation moving sutainably down to 2.0%. We also decided to reduce our securities holdings. We're committed to maintaining our economy's strength by supporting maximum employment. The unemployment rate has moved up but remains low at 4.2%. Overall conditions in the labour market are now less tight than during the pandemic in 2019. The labour market is not a source of elevated inflationary measures," says Fed chairman Jerome Powell during the press conference announcing the rate cut.

"We are not on any preset course. We will continue to make our decisions (for further rate cuts) meeting by meeting.We know that reducing policy restraint too quickly could reduced further progress on inflation. At the same time reducing policy restrant too quickly could unduly weaken economic acitivity and employment."

This is the first interest rate cut by the Fed since 2020 at its September 17-18 meeting. The market expects further interest rate cuts this year depending on the inflation trend.

“We have reached a point in the economic cycle where policymakers are attending equally to the risks of labour market deterioration and price growth, so rates should fall this time and in the coming months regardless of how inflation tracks,” says Jacky Lam, financial consultant at Charles Schwab Hong Kong.

Inflation data will likely still factor into the Fed's decision-making, and the 0.3% core inflation increase announced last week is expected to present a continuing challenge to the Fed as it seeks to cut interest rates further.

Inflation has slowed as pandemic disruptions have faded and amid a temporary immigration boost to the workforce. But inflation is expected to remain sticky in view of the loose fiscal policy and the impact of mega forces, limiting how far the Fed can cut, according to the BlackRock Investment Institute in its weekly commentary issued on September 16.

Adjusted for inflation, the current fed funds rate is 2.5%, the highest since 2007. In contrast, inflation in 2007 rose rather than fell (see graph). Interestingly, in 2007 the rate cutting cycle started on September 18, according to Gary Dugan, chief executive officer of The Global CIO Office.

“If the Fed's goal is to bring real rates down to +50bp, this would imply a target fed funds rate of approximately 2.75%, based on a 2.25% inflation target. Achieving this would require a total rate cut of 250bp. At a pace of 25bp cut per meeting, the Fed could take roughly a year to reach its desired target,” Dugan says.

Longer term, the Fed is expected to cut rates by at least 100bp by the end of the current year at 4.25% and close next year at around 2.75%.

US stocks rose about 4% last week, led by technology companies. US 10-year treasury yields touched 15-month lows, with markets pricing steep Fed cuts that look overdone.

Markets have been quick to price in rate cuts after the Fed finished its fastest hikes since the 1980s – and price them out when inflation spooked to the upside, according to BlackRock.