United States: Fed cuts interest rates

The US Federal Reserve has cut interest rates by 50 basis points, signaling the central bank’s confidence that its war against inflation is coming to an end. How far and how fast the Fed cuts rates moving forward remains to be seen.

Fed Chair Jerome Powell told lawmakers earlier this year that the era of near-zero interest rates is likely over, the central bank projected in June that the median interest rate would drop to 4.1% in 2025 and 3.1%in 2026.

The Fed further lowered its median rate forecast Wednesday to 3.4% next year and 2.9% in 2026, as well as in the long run, according to new economic projections.

“This would only be the first cut of a rate-cutting cycle. The size and frequency of future cuts will give us a better understanding of whether the Fed believes they are behind, or ahead of, ‘the curve,’” said Jonathan Ernest, an economics professor at Case Western Reserve University.

The jobless rate ticked up to 4.3% in July and clocked at 4.2% last month. That’s relatively low by historical standards but still a sign of labor market “cooling” the Fed had been watching for as it waited to cut rates.

While some economists believe the Fed could have started cutting rates in July, the next few months are critical as the central bank attempts to bring the economy in for a “soft landing,” maintaining its dual mandate of low inflation and maximum employment as it brings down rates.

 

Gold price on the rise

Gold prices held steady on Tuesday as the dollar eased, while investors looked forward to key US inflation data that could offer clues on how soon the Federal Reserve can cut interest rates.

Spot gold price was flat at US$2,350.85 per ounce by 0350 GMT, after rising about 1% in the previous session. US gold futures rose 0.8% to US$2,352.00.

"A very strong dollar picture supported by a change in the US monetary policy stance where the Fed starts looking for evidence to kick start interest rate hikes instead of easing could be a major risk as we could see a further corrective move in spot gold," said Kelvin Wong, a senior market analyst for Asia Pacific at OANDA.

However, in the short term, spot gold is still more skewed towards the positive side rather than the negative side and US$2,310 is a key short-term support for this week, Wong added.

The core personal consumption expenditures price index (PCE), the Fed's preferred inflation measure, is due on Friday.

Fed meeting minutes released last week showed that the policy response, for now, would involve maintaining the benchmark policy rate at its current level but also reflected discussions of possible further hikes.

Traders' bets indicated rising skepticism that the US central bank will lower rates more than once in 2024, currently pricing in about a 62% chance of a rate cut by November according to the CME FedWatch Tool.

Bullion is known as an inflation hedge, but higher rates increase the opportunity cost of holding non-yielding gold.

Vietnam's central bank will stop auctioning gold in the domestic market and launch a new measure to stabilize domestic prices, it said on Monday.

 

First Republic Bank may be next to collapse

The San Francisco-based bank could be the next financial institution to collapse, signaling that last month's banking crisis isn't over yet. Its shares plummet 43% on Friday and 75% on the week as investors feared it would be shuttered by regulators.

Since Silicon Valley Bank’s (SVB) failure last month, First Republic’s stock is down roughly 97%.

Federal regulators are reportedly trying to figure out ways to prevent First Republic, which is headquartered in San Francisco, from failing — including asking other banks to step in and make bids.

The regional bank may ultimately be taken over by the Federal Deposit Insurance Corporation (FDIC), like SVB and New York's Signature Bank.

The selloff was triggered by a terrible earnings report revealing that First Republic lost more than US$100 billion in deposits following the SVB collapse. The outflow came even as a group of megabanks attempted to rescue First Republic by depositing US$30 billion. 

First Republic’s depositors were concerned that the bank would get hit with a similar bank run. The bank also had large unrealized losses on its balance sheet that raised the risk of a collapse.

The extended banking crisis has ramifications for the US economy.

Regional banks such as First Republic are key lenders for area businesses. Even banks that aren’t struggling are pulling back their lending to reduce risk, hurting employers’ ability to hire and grow.

 

US Fed indicates further rate hikes

According to Reuters, US Federal Reserve policymakers on Wednesday signaled they will push on with more interest rate hikes, with several supporting a top policy rate of at least 5% even as inflation shows signs of having peaked and economic activity is slowing.

"I just think we need to keep going, and we'll discuss at the meeting how much to do," Cleveland Fed President Loretta Mester said in an interview with the Associated Press.

The remarks appeared to reflect a widely shared view among her fellow policymakers, most of whom as of December 2022 had penciled in a 5.00%-5.25% policy rate in coming months.

Mester said that for her part she expects the Fed's policy rate to need to go a bit higher than that, and stay there for some time to further slow inflation.

The Fed's benchmark overnight lending rate currently hovers in a target range of 4.25% to 4.50%, and investors expect the Fed to lift that rate by a quarter of a percentage point at the end of its January 31-February 01 meeting.

Spending, inflation, and manufacturing - all reported earlier on Wednesday - have helped stoke expectations that the Fed will end its current round of rate hikes sooner than Mester and most of her colleagues expect, with the policy rate just shy of 5%.

The central bank began raising borrowing costs in March 2022, when the policy rate was in the 0%-0.25% range and inflation was starting to make a climb that would see it rise to 40-year highs, several times the Fed's 2% target.

Like Mester, St. Louis Fed President James Bullard, speaking with the Wall Street Journal earlier, said he too sees the policy rate rising to the 5.25%-5.50% range, and added that policymakers should get it above 5% as quickly as we can.

Several Fed officials have expressed support for slowing to quarter-percentage-point rate increases, after last year's much faster pace of rate hikes in mostly 75-basis point and half-point increments.

Bullard expressed more impatience. Asked if he was open to a half-percentage-point increase at the Fed's upcoming meeting, he asked "why not go to where we're supposed to go? ... Why stall?"

The answer may in part be found in the latest "Beige Book" report published by the Fed on Wednesday. The compilation of survey data from the central bank's districts around the country showed that while prices continued to increase, the pace in most districts was reported to have slowed.

And while employment continued to grow at a modest to moderate pace in much of the country, and several Fed districts reported modest economic growth, the New York Fed reported a contraction in activity, four other districts reported slowdowns or slight declines, and most expected little growth ahead.

Still, Fed policymakers say the mistake they do not want to make is to stop short of defeating inflation, only to have to raise rates even more to do the job later on, as happened in the 1970s and 1980s

Even Philadelphia Fed President Patrick Harker, who is generally less hawkish than Mester or Bullard and wants the Fed to switch to quarter-percentage-point hikes ahead, sees a few more rises in borrowing costs before a pause.

Dallas Fed President Lorie Logan also supports a slower rate hike pace ahead because of the uncertain outlook and the need to be flexible. But she also signaled the Fed may need to raise rates higher than is widely expected to keep financial conditions tight enough to press down on inflation.

"I believe we shouldn’t lock in on a peak interest rate," Logan said in Austin, Texas. She added that even once inflation is headed convincingly down to 2% and the Fed does stop raising rates, the risks will be two-sided and that further rate hikes could be in the offing.

In an interview with Reuters on Wednesday, outgoing Kansas City Fed President Esther George said she felt rates would have to move higher than many of her colleagues anticipate, but that she also would have been willing to move in smaller increments.

“People’s expectations about inflation are beginning to move down,” George said, an observation based on conversations with contacts in her Midwest district. “So I’m comfortable beginning that stepped-down process ... I’d be happy to do 25s if I were there.”

George will retire right before the Fed's next meeting and will not participate in it.

But she added, “We still have upside risk to inflation. I don’t think I’ve reached a point where I think it is clearly falling. There are enough issues out there to say we have to guard against them.”

Fed Chair Jerome Powell, who tested positive for COVID-19 on Wednesday and is experiencing mild symptoms from the virus, said after last month's policy meeting that the inflation battle had not been won and that more rate hikes were coming in 2023.