Fed surprises economists with better-than-expected 50 bps rate cut; what next?

The Federal Reserve on Wednesday announced a reduction of 50 basis points (bps) in the benchmark interest rates, better than most economists' expectations of 25 bps. Wall Street, however, gave up an initial spike following the announcement with some analysts anticipating that the positive news was already priced in. 

The rate cut in the world's largest economy is the first in more than four years, and comes at a time when investors around the globe keenly looked out for the onset of an impending easing of borrowing costs. 

Lowering the funds range, the benchmark lending rate, by half a percentage point, the US central bank exuded confidence that inflation will keep receding to its annual goal of 2 per cent.

Federal Reserve Chairman Jerome Powell said that the US labour market is "still at very solid levels" with no sign of a recession and with solid growth and lower inflation.

He also mentioned that the central bank might have started lowering rates sooner driven by a surprisingly weak July jobs report if it had noticed that data earlier.

How Wall Street reacted

The S&P 500 index declined 0.3 per cent for the day, reversing gains to the tune of 1 per cent shortly after the announcement. 

The Dow Jones Industrial Average and the technology stocks-heavy Nasdaq Composite also finished the day 0.3 per cent lower each.  

The dollar index—which gauges the greenback against six currencies excluding the rupee—recovered initial losses following the announcement but then managed to rise 0.1 per cent to almost 101.

Investors are now focusing on what the US central bank would do next, with the much-anticipated September cut now behind.

What experts say

Many economists believe that the US central bank may not be able to maintain the same pace of monetary policy easing going forward. 

"This forceful move was characterized by Chair Powell as a “recalibration” to preserve the currently strong labor market from downside risks," said Madhavi Arora, Lead Economist at Emkay Global Financial Services.

"This start to the easing cycle provides some space to emerging markets to kick-start theirs too, but with low global volatility thus far, the RBI is likely to remain focused on domestic dynamics, with a first rate cut by December... A case for an early cut is still less likely, and we continue to see shallow cuts by both the Fed and RBI in this cycle," Arora added.

“The Fed opened the rate cut cycle with a bang with 50 bps cut in line with changed market expectations… From Inflation is transitory to higher rates for longer, the Fed has come a long way to meet market expectations,” said Nilesh Shah, MD at Kotak Mahindra AMC.

“This rate cut will facilitate flows to the emerging market assets with wekaer dollar and lower rates,” said Shah.

With inputs from agencies