Early last week, few questioned whether the Federal Reserve would cut interest rates; the only question was whether they would cut by a quarter or a half of a percent.

We know now that the Fed cut half a percent (or 50 basis points), but two questions remain. First, why did they cut as much as they did? Second, how much more will they cut?

Perhaps I should start with why they said they cut 50 basis points. Chair Powell said, “The US economy is in good shape. It’s growing at a solid pace. Inflation is coming down. The labor market is in a strong pace. We want to keep it there. That’s what we’re doing.”

The conspiracy theorist in me thinks that Jay Powell would like to be called ‘The Maestro,” like former Fed Chair Alan Greenspan was back in the day.

Greenspan was widely credited with pulling off a soft landing in 1994 when his Fed raised interest rates aggressively to prevent inflation as the economy recovered from the recession in the early 1990s. The economy continued to grow and was considered a success for Greenspan. However, the bloom came off his rose after the 2008 Global Financial Crisis.

I also think Powell & Company are concerned about the employment picture. The unemployment rate has ticked up enough to trick what is called the Sahm Rule.

I’ve written about the Sahm Rule before (click here for the whole article), which states that recessions occur after unemployment rises by half a percentage point relative to the previous 12 months.

Claudia Sahm, the former Fed economist who created the rule, has been on several podcasts I listen to, saying it’s just one indicator, and there haven’t been enough recessions to have a robust signal. I also saw the chief Goldman Sachs economist at a conference last week, who said it hasn’t been a good signal overseas.

Still, it was clearly enough for the Fed to take preemptive action. Not surprisingly, markets are looking ahead to what’s next, and investors are now pricing 50-75 basis points of more cuts before year-end.

The Fed’s dot plot suggests more cuts, although they are less aggressive than the market. In any case, the market has gotten this wrong for the last year.

A thoughtful article from Morningstar (which can be found here) argued that people are overly excited about the cut and that it’s mostly noise, and I agree.

They included a table showing the forward returns for the S&P 500 after cuts going back to 1974. The average return one year after a cut was 15 percent.

That’s welcome news, but the last three data points aren’t as uplifting. Stocks were lower in two of the three periods, 2001 and 2007. The third one, in 2019, was pretty skewed by the pandemic. The cut took place in July 2019, and nine months later, the world was rocked by the virus, so it’s not clear how that would have turned out.

For now, though, we can enjoy the cuts and see where everything goes from here. I am as hopeful as anyone that we will get a soft landing, inflation keeps cooling, and markets keep humming along. I’m a natural worrier, so I can see how things could go wrong, and the main thing to keep an eye on, in my opinion, is services inflation. More to come…