Why would the Fed cut their overnight lending rate?

The Fed voted to hold the Fed Fund interest rates steady last week.  In fact, they are staying on the track of reducing the Fed Fund rates and a majority of Committee members voted to reduce rates 3 times during 2024. 

The Stock Market celebrated with the biggest positive returns in 2024 and the biggest one week since December, 2023. 

Why would the Fed cut their overnight lending rate? 

There are several important reasons that the Fed is willing to stay on track to reduce the Fed Funds rates from its current 5.25% – 5.50% to a target (based on the dot pattern) of 3 cuts down to 4.50% – 4.25%?  Even without a significant reduction below the current annualized rate of inflation of 3% or better, the Fed is inclined to reduce rates and probably sooner due to the following reasons:

• Even if inflation climbed to 3.0% or more, the spread between short-term interest rates (1-5 years) at 4.6% and the rate of inflation is too wide. They would like to see short-term rates at or below the rate of inflation.  Otherwise, monetary policy is too restrictive and borrowing costs for businesses as and home buyers is punitive.
• The Fed believes that the economy is decelerating (slowing down), and they would like to see interest rates less restrictive. While corporate earnings have been well above expectations, growing 3.5% or better since 3Q 2023, companies are beginning to conduct layoffs and gear up for a softening economy.  The Fed is aware of this and wants to provide easier credit for the economy.
• If the Fed is going to normalize interest rate conditions, they need to do it long before the election in November so as not to look as if they are trying to interfere with the Election and any perceived advantage for one party over another.
• The Fed understands that higher interest rates are a material drag on current government debt. Higher interest rates are now responsible for over $1 trillion in finance charges to the Government, exceeding the total defense budget.  This is unsustainable.
• Interest rates need to come down to bring down the rates offered at the Treasury auctions. Treasury Secretary Yellen has indicated they will suspend some Treasury auctions until such time that interest rates come down as the finance rates on these auctions are egregious.

A big week for Central Banks around the world.

Many countries around the world also held central bank meetings over the last few weeks signaling their future plans on their monetary policy.

The Swiss National Bank, citing progress on inflation, became the first among global peers to cut interest rates.  Norway signaled no such move to lower rates for at least another 6 months.  As was expected, The Bank of Japan finally ended its negative interest rate regime (-0.25%) and raised rates to 0%.  This was a long time coming and a good sign that economic conditions have finally picked up in Japan.

In Africa, central banks in the continent’s biggest economies, including Egypt and Kenya, all maintained tight monetary policies to contend with lingering and sticky inflation.

Several other developed nations signaled optimism that their rate cuts were still on the table for later this year, similar to the United States stance.

The Fed’s Projections.

As referenced above, much of the Fed’s motivation for reducing the Fed Funds was that inflation would decline and economic conditions soften.  Their longer-term expectations were evident in the data that they put forth this past week.  See table below: