A new era of easy money dawns as Fed nears first rate cut since 2020

The Federal Reserve is nearing the end of an era as the central bank looks to cut interest rates for the first time in four years.

If the Fed eases monetary policy at its next meeting on Sept. 18 as expected, it will officially mark the termination of the most aggressive inflation-fighting campaign since the 1980s. Its benchmark rate is currently at 5.25% to 5.5%, a 23-year high.

The central bank's new era of easy money is expected to last through 2025 and 2026. That shift will ripple through the US economy by making it cheaper for Americans to borrow what they need to buy houses and cars or credit card purchases.

Businesses will also have an easier time taking out loans to fund their operations.

"We're starting this rate cut cycle, it looks like, in September at a place that fed funds hasn't been in more than 20 years," WisdomTree head of fixed income strategy Kevin Flanagan told Yahoo Finance.

"You have a whole generation of investors who have never experienced rate cuts at these levels of interest rates."

What the Fed rate decision means for bank accounts, CDs, loans, and credit cards

For Fed Chair Jerome Powell, this inflection point may allow him to claim an accomplishment that eluded many of his predecessors, including his inflation-fighting idol Paul Volcker.

Powell has said how much he admires Volcker, who hiked interest rates to an eye-popping 22% in the 1980s in an effort to get inflation under control. But Volcker wasn’t able to avoid a recession as his high rates took a toll on millions of Americans and businesses.

A new era of easy money dawns as Fed nears first rate cut since 2020
Federal Reserve Chairman Jerome Powell outside of the Jackson Hole Economic Symposium In Wyoming on Aug. 23. (AP Photo Amber Baesler) (ASSOCIATED PRESS)

Powell had his own Volcker moment in 2022 when he promised "pain" as the Fed took its own rate-hiking campaign into overdrive. He then experienced a banking crisis in the spring of 2023 that tested the central bank as it worked to ease panic among bank depositors across the US.

But the goal that is now within his reach is the ever-so-rare "soft landing," in which inflation falls back to the Fed’s 2% target without forcing the US economy into a painful downturn.

Esther George, former Kansas City Fed president, said the Fed will not have finished its job until it secures its 2% inflation target.

"They may be on the golden path, but for me, [it's] too soon to say we know the path we’re on," George said. "The Fed’s credibility of achieving 2% is coming into better focus, but we’re not there yet."

A new era of easy money dawns as Fed nears first rate cut since 2020
Paul Volcker, who led the Fed's inflation-fighting campaign of the 1980s, smokes a cigar during a meeting in Washington D.C. in 1982. (Bettmann via Getty Images)

There is still the danger that a cooling labor market could worsen, which has the potential to drag down the US economy and force the Fed to lower rates more aggressively .

That’s the debate that will likely define the coming days as the Fed prepares for its next meeting.

Powell made clear in his last speech that the central bank is poised to begin its rate-cutting cycle, saying in Jackson Hole, Wyo., that "the time has come for policy to adjust."

But he was silent on how big the first cut could be and whether it would definitely happen at the September meeting.

Atlanta Fed president Raphael Bostic told Yahoo Finance that September or November is "definitely in play" and that an initial 25 basis point reduction "could be the most appropriate way forward."

Philadelphia Fed president Patrick Harker told Yahoo Finance in another interview that he expects the central bank to start with a 25 basis point cut, but he would be open to a larger cut if the labor market deteriorates suddenly.

For now, traders are betting on a small cut to start. The odds of a 25 basis point reduction in September are now at roughly 65%.

Fed predictions for 2024: What experts say about the possibility of a rate cut

Playing catch up

The Fed’s multiyear fight against inflation began with what many consider a misstep and included plenty of ups and downs along the way.

The misstep was believing that inflation would be "transitory." That was the belief for much of 2021 as Fed policymakers watched prices move higher due to pandemic dislocations and supply chain disruptions caused by the COVID-19 health crisis.

But when price increases spread to a broader range of goods and services, it was clear that inflation was proving to be more persistent than previously thought — especially as oil prices spiked following the start of Russia’s war in Ukraine.

In March 2022 the annual change in inflation as measured by the Consumer Price Index hit 8.5%, the highest mark in 40 years. Even excluding food and energy, the rise was still 6.5%, unacceptably high when compared with the Fed's 2% target.

That month, the Fed decided at its policy meeting to raise rates for the first time since 2018, starting with a small quarter-percentage-point cut.

"As I looked around the table at today's meeting, I saw a committee that's acutely aware of the need to return the economy to price stability and determined to use our tools to do exactly that," Powell told reporters after that meeting.

But inflation kept heating up. The annual rise in CPI accelerated to 8.6% in May and 9.1% in June.

The Fed then switched into catch-up mode, pulling the trigger on a 0.75% rate hike, the largest in more than a quarter century. It would be the first of four 0.75% hikes in a row.

As Powell became more aggressive, he sent the markets plunging with an August 2022 speech in which he warned that the Fed's "overarching focus right now is to bring inflation back down to our 2% goal" and that this will cause "some pain to households and businesses."

"Failure to restore price stability would mean far greater pain," he added.

The Fed went back to quarter-point hikes in early 2023, defying some predictions that a regional banking crisis roiling the financial world at that time might stop the Fed from tightening further.

The last hike came in July 2023, settling the fed funds rate at a 22-year high of 5.25% to 5.5%. It has been at that level ever since.

'Things look pretty good'

Investors began 2024 thinking the Fed’s inflation-fighting campaign was done and hoping for six cuts over the course of the year.

That immediately led to tension between the Fed and Wall Street. Fed officials repeatedly pushed back on those expectations, saying they needed to see more progress on inflation before they would be ready to stop raising rates.

Their caution appeared to be warranted when inflation heated back up in the first quarter, causing policymakers to revise their own predictions for multiple cuts to just one for all of 2024.

But as inflation resumed its downward crawl in the second quarter and unemployment started to tick higher, some Fed critics reemerged.

They argued the central bank had held rates too high for too long and risked upending the possibility of a soft landing.

Alan Blinder, former vice chair of the Federal Reserve and professor of economics at Princeton University, is among those who argued the Fed could have started cutting rates in July.

The Fed, he told Yahoo Finance, is a "little behind the curve."

Blinder doesn’t think the chances for a recession have increased, noting that the economic data doesn’t look much different now than it did in July. But the job market can’t cool "too much more" without a recession, he said.

"[The unemployment rate] has been going up smoothly — a tenth of a point. You don’t want to keep that up for a year. If you do that, you’re up 1.2% points," he added in an interview.

When asked if the labor market can cool without tipping the economy into a recession, the Atlanta Fed’s Bostic said, "It can, and we will have to see whether it does."

But a recession, he added, "is not in my outlook."

Former Cleveland Fed president Loretta Mester said the central bank now has a "good shot" at achieving a soft landing.

The Philadelphia Fed’s Harker agreed.

"Right now things look pretty good," he said.