US Federal Reserve cuts key rate as government shutdown clouds economic outlook

Fed rate cuts

Wednesday’s decision brings the Fed’s key rate down to about 3.9%, from about 4.1%. The central bank had cranked its rate to roughly 5.3% in 2023 and 2024 to combat the biggest inflation spike in four decades. Lower rates could, over time, reduce borrowing costs for mortgages, auto loans, and credit cards, as well as for business loans.

Second rate cut this year

This is the second time this year the Federal Reserve has cut its key interest rates. The move comes amid a fraught time for the central bank, with hiring sluggish and yet inflation stuck above the Fed’s 2% target. Compounding its challenges, the central bank is navigating without the economic signposts it typically relies on from the government, including monthly reports on jobs, inflation and consumer spending, which have been suspended because of the government shutdown.

More rate cuts coming

The Fed has signaled it may reduce its key rate again in December but the data drought raises the uncertainty around its next moves. The Fed typically raises its short-term rate to combat inflation, while it cuts rates to encourage borrowing and spending and shore up hiring.

Right now its two goals are in conflict, so it is reducing borrowing costs to support the job market, while still keeping rates high enough to avoid stimulating the economy so much that it worsens inflation.

On Wednesday, the Fed also said it would stop reducing the size of its massive securities holdings, which it accumulated during the pandemic and after the 2008-2009 Great Recession. The change could over time slightly reduce longer-term interest rates on things like mortgages but won’t have much impact on consumer borrowing costs.

The Fed purchased nearly $5 trillion of Treasury securities and mortgage-backed bonds from 2020 to 2022 to stabilize financial markets during the pandemic and keep longer-term interest rates low. The bond-buying lifted its securities holdings to $9 trillion. In the past three years, however, the Fed has reduced its holdings to about $6.6 trillion. To shrink its holdings, the Fed lets securities mature without replacing them, reducing bank reserves.

In recent months, however, the reductions appeared to disrupt money markets, threatening to push up shorter-term interest rates. Two of the 12 officials who vote on the Fed’s rate decisions dissented, but in different directions.

Fed governor Stephen Miran dissented for the second straight meeting in favor of a half-point cut. Miran was appointed by President Donald Trump just before the central bank’s last meeting in September.

Jeffrey Schmid, President of the Federal Reserve Bank of Kansas City, voted against the move because he preferred no change to the Fed’s rate. Schmid has previously expressed concern that inflation remains too high.

Trump vs Fed Chair

Trump has repeatedly attacked Powell for not reducing borrowing costs more quickly. In South Korea early Wednesday, he repeated his criticisms of the Fed chair. “He’s out of there in another couple of months,” Trump said.

Powell’s term ends in May. On Monday, Treasury Secretary Scott Bessent confirmed the administration is considering five people to replace Powell, and will decide by the end of this year.