SUMMARY
- With both core and headline inflation above the official 2% target for over three years, financial conditions at their loosest since May 2022, and the labor market not showing signs of significant cooling, it’s debatable whether the Fed’s recent 50 basis point rate cut—historically reserved for times of crisis—was justified.
- The Fed may be overcompensating for past mistakes by acting more aggressively now, perhaps trying to avoid the errors of moving too slowly ahead of prior recessions. One concern is whether the Fed’s more lenient approach to inflation will spur growth, potentially leading to inflation rising again. Further, cutting rates with inflation still above 2% could encourage risk-taking behavior and rising asset prices (the forward price-to-earnings ratio for the S&P 500 is currently elevated at 21.5, but still below the Tech Bubble peak of 25.1, indicating that valuations could become even more stretched).
- Both the Fed and markets are expecting the equivalent of another 50-basis-point reduction by year-end, implying a 25-basis-point cut at each of the remaining FOMC meetings in 2024. While the 1970s were a much different economic period than today, it serves as a reminder that inflation can return in a “second wave.”
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