Investing.com -- The Federal Reserve’s recent decision to cut interest rates by 50 basis points (bps) marks an aggressive shift in policy, as Chair Jerome Powell emphasized the central bank's commitment not to fall "behind the curve."
This initial "hawkish 50" rate cut has provided some relief to investors, indicating that the Fed is prepared to act decisively if economic conditions weaken.
According to UBS, this move could be seen as a reactivation of the Fed "put," where further rate cuts could be triggered if data, particularly in the labor market, starts to deteriorate. The markets have responded positively, but the focus now shifts to the effectiveness of these cuts and whether they can secure a soft landing for the U.S. economy.
While UBS believes a soft landing is likely, investor confidence in an extended economic expansion will depend on future data, especially labor market indicators such as the September payroll report.
Looking beyond the immediate future, UBS notes that the debate is now centered on the terminal or neutral rate—how far the Fed will cut rates in this cycle.
Although the soft landing scenario is not contingent on whether rates fall to 3% or 3.5%, the outlook for the neutral rate reflects broader questions about the post-pandemic economy. UBS highlights the possibility of a "Roaring '20s" regime, marked by stronger growth and inflation than pre-pandemic norms, as an underappreciated upside risk.
For now, economic data remains solid, with growth estimates for Q3 around 2.5%-3%. UBS suggests that investors are increasingly comfortable with a macro environment of preemptive rate cuts, steady disinflation, and moderate growth. However, uncertainties remain, particularly regarding the long-term trajectory of the U.S. economy and the eventual neutral rate.
“Powell described the rate cut as a “recalibration” of policy to make it less restrictive, and investors may have to recalibrate their own expectations for the terminal/neutral rate,” UBS said in a note.
“It’s very unlikely that the Fed will cut only 75bps total this cycle—100bps this year seems nearly certain. But the outlook for 2025 is fairly wide open, especially with uncertain fiscal policy post-election,” it added.
The bank concludes that while markets have priced in the soft landing, volatility could reemerge as investors wait for clearer signs of the soft landing will extend into a more prolonged period of economic growth.