Fed "megaphone": Rate cut between meetings is very unusual, far more than just because of the stock market plunge

The "megaphone" of the Federal Reserve and well-known Wall Street Journal reporter Nick Timiraos wrote in his latest article that Monday's market plunge increased the risks of recession and more thrilling financial market accidents. However, given that Federal Reserve officials laid the groundwork for a 25 basis point rate cut at next month's meeting last week, it may take further deterioration in economic prospects in the coming weeks to compel them to make a larger response.

Officials will not meet again until September 17-18. If last month's broadly weak employment report signals a new worrisome trend, they may debate whether to start a series of rate cuts with a larger magnitude, namely 50 basis points.

However, cutting rates before the scheduled policy meeting, that is, between policy meetings, would be very unusual. These measures are usually reserved for significantly deteriorating market conditions, far beyond just stock market plunges.

"They have set a very high bar for this," said Steven Blitz, Chief U.S. Economist at GlobalData TS Lombard. "I think their preferred approach would be to come out and say, 'If things continue to evolve, a 50 basis point rate cut in September is possible.'"

Last week at a press conference, Federal Reserve Chairman Powell hinted that officials plan to cut rates by 25 basis points next month. This came after the latest employment report exacerbated expectations for a 50 basis point rate cut, as hiring in the U.S. slowed last Friday according to the Labor Department and the July unemployment rate rose more than expected.

Then on Monday this week, a stampede event accelerated the decline in Asian markets as people exited popular investment strategies that borrowed cheap yen to buy stocks. This led some panicked investors to speculate that the Federal Reserve would intervene between scheduled policy meetings. The unwinding of these so-called arbitrage trades began last month but accelerated after the Bank of Japan raised rates last week.

Nevertheless, Matthew Luzzetti, Chief U.S. Economist at Deutsche Bank, stated that the Federal Reserve will not "react too quickly to events that occur within a few days, as this may reflect pricing or other developments in the market that may be reversed later." San Francisco Fed President Daly said on Monday that there are reasons to believe that the rise in the unemployment rate is being driven by less concerning factors, such as an increase in temporary layoffs rather than permanent layoffs. A report on the business conditions of the service industry on Monday also eased concerns about a rapid economic slowdown.

Analysts say that the market trend indicates that there has not been a large-scale flight to safety, which should be common if investors were more concerned about deteriorating economic fundamentals. Instead, the intensified selling that began over the weekend is more driven by technical factors, including the unwinding of crowded trades in Japanese stocks and large tech companies.

High stock prices, stable income, and job growth have always been key engines of economic expansion, puzzling economists with their resilience. If continued stock market declines lead to companies cutting investment plans or laying off workers, it could change the outlook for the U.S. economy, but assessing how any sell-off reshapes the outlook may take several days or weeks Although the Federal Reserve's meeting is still six weeks away, Powell has the opportunity to comment on the evolving outlook later this month. Powell often uses the central bank meeting at the end of August to deliver highly anticipated speeches, thereby shaping his broad outlook. The meeting is scheduled to take place on August 23 in the iconic Grand Teton Mountains of Wyoming. Economic and market developments over the next three weeks may influence any remarks.

Bullard said last week, "The entire Federal Reserve Board is assuming that the economy in September will be the same as last Monday, and you can slowly cut interest rates as usual, the market is sending a signal to the Federal Reserve." They are telling the Federal Reserve, "Your policy is too tight, no, you cannot assume that everything will go smoothly, and you are dragging your feet on rate cuts."

The Federal Reserve raised its benchmark federal funds rate to a range of 5.25% to 5.5% in July 2023 to address rising prices. Inflation has slowed significantly over the past year. The latest market reaction is noteworthy, as just a few months ago, some investors were concerned that the Federal Reserve might not raise rates high enough to curb inflation. Officials are reluctant to lower rates until they see more evidence that price pressures will not be reignited. Expectations of slowing economic growth, cooling inflation, and potential rate cuts by the Federal Reserve may begin to help the interest rate-sensitive parts of the economy in the coming months.

According to data from the Mortgage News Daily, the average interest rate for a 30-year fixed-rate mortgage has dropped to 6.34%, down from 6.81% a week ago, and is the lowest since April 2023 when concerns about potential regional bank bankruptcies triggered a bond market rebound. Borrowing costs typically slow down when future rate cuts are expected.

Therefore, rate cuts during scheduled policy meeting intervals are usually taken when financial markets face more severe pressure due to rapidly deteriorating prospects, or when the Federal Reserve wishes to convey its signal in an unexpected manner.

Since Powell became Federal Reserve Chairman in February 2018, the Federal Reserve has cut rates between policy meetings twice, both occurring during the spread of the COVID-19 pandemic in March 2020. In addition, rate cuts between meetings occurred during the following periods:

• In October 1998, the Federal Reserve cut rates again a few weeks after the initial rate cut to prevent a market collapse following the collapse of Long-Term Capital Management.
• In January 2001, after months of weakness in tech stocks, deteriorating economic data led to an unexpected 50 basis point rate cut.
• The Federal Reserve had already cut rates by 1 percentage point in the fall of 2007, but deteriorating economic conditions and a large trading loss at a French investment bank prompted the Federal Reserve to make an emergency 75 basis point rate cut a week before the scheduled policy meeting in January 2008