The Federal Reserve will convene its two-day Federal Open Market Committee policy meeting later this month. The financial markets overwhelmingly expect the US central bank to reduce the benchmark federal funds rate by a quarter point. President Donald Trump and senior administration officials have been begging for a 25-basis-point reduction for months. But will it achieve what the White House wants, namely, lower borrowing costs for businesses, consumers, and the government? A trip back to September 2024 is warranted.
Federal Reserve Visits Treasury Island
The Atlanta Fed’s Market Probability Tracker and the CME FedWatch Tool show investors are widely penciling in the first interest rate cut since December. The Eccles Building has maintained its target rate within a range of 4.25% and 4.5%, with policymakers insisting that they can be patient before adjusting policy, given the growing economy and intact labor market.
Economic observers can debate whether the Fed should have waited this long before restarting its rate-cutting cycle. Still, the key question is: Will the central bank ultimately make a difference?
On paper, the monetary authorities cutting the fed funds rate should lead to lower Treasury yields. But the printing press kings are only partially influential in the bond market. When the institution initiated its easing campaign with a super-sized 50-basis-point reduction, the opposite occurred: yields went up. While the Federal Reserve was cutting by a full percent, the benchmark ten-year Treasury yield soared about 120 basis points to 4.617%.
The upward movement stumped many experts, with economists suggesting fiscal worries, bullish economic prospects, and/or a flooded capital market fueled the divergence. Fast forward a year since Fed Chair Jerome Powell and his colleagues lowered rates – has anything changed? Not really.
After a federal court ruled that much of President Trump’s sweeping global tariffs are illegal, Wall Street became frightened that Uncle Sam would have to repay the $131 billion in levies collected so far and forego the $3 to 4 trillion in potential revenue the Congressional Budget Office forecast. This sent long-term yields through the roof to kick off the post-Labor Day trading session, with the 20- and 30-year yields eyeing the 5% mark.
Despite a sluggish start to 2025, the US economy rebounded with a better-than-expected 3.3% GDP growth reading in the second quarter. Looking ahead, the Atlanta Fed’s GDPNow Model signals a 3% expansion for the third quarter. With domestic and foreign corporations committing trillions of dollars in private investment to the US economy over the next few years, it is unlikely that the country will suffer a sharp economic downturn.
Lastly, the capital markets are being flooded with fresh Treasury issuance. On Sept. 4, the Treasury Department will sell a record $100 billion in four-week bills that will settle on Sept. 9. Some market watchers say the money markets have a strong appetite for them, while others argue that these issuances are crowding out private capital. Whatever the case, debt management is a little different from a year ago.
What About the Little Guy?
So, what does this mean for the little guy?
Sure, a lower federal funds rate might trim around the edges of sky-high credit card interest rates. However, if one or two rate cuts for the rest of the year have little impact on lowering Treasury yields, it will have minimal effect on mortgage rates or auto loans. The mortgage market tracks the ten-year, while borrowing costs for automobiles follow the five-year. Plus, since a September cut is already baked into the cake, traders are looking beyond this month.
With Wall Street still bracing for a tarifflation epidemic and monitoring a potentially deteriorating labor market, it is possible that the Fed engages in a stop-and-start approach to monetary policy. If the central bank has lost credibility stemming from the pandemic, this will further erode confidence in the century-old institution. Would overhauling the entity restore public trust? Like everything else in the United States, one side will renew its faith in the Federal Reserve, and the other will assert that it is a political tool.
