The Fed just cut rates for the first time this year. Here's everything you need to know

The Federal Reserve cut rates for the first time since December 2024, lowering the benchmark interest rate by a quarter percentage point to 4%-4.25. Chair Jerome Powell's measured tone and updated projections suggest the central bank is increasingly concerned about balancing inflation risks against a cooling jobs market.

Interestingly, Powell said there was no widespread support for a larger, 50 bp cut. Only the recent Trump appointee, Stephen Miran, dissented the decision in support of a half-point cut.

Key economic projections

Here are the key numbers from the Fed's latest Summary of Economic Projections (SEP):

• Interest rates: Median projection shows 50 bps in additional cuts this year

• Unemployment: Expected to rise to 4.5% this year from current 4.3%

• Inflation: PCE inflation to moderate, but 2026 forecast raised from 2.4% to 2.6%

• GDP growth: 2026 estimate revised up to 1.8% from 1.6% in June projections

• Terminal rate: Lowest Fed official sees rates bottoming at 2.4% by 2027

The Fed is highly divided on this outlook. The dot-plot noted nine out of the 19 Fed members in favour of 50 bps of additional cuts this year, while six think they should keep rates unchanged.

Labour market shift drives policy change

Powell stressed that the Fed's focus has shifted decisively toward employment concerns, describing the current environment as "low firing, low hiring." The central bank noted job gains have slowed and unemployment has edged higher, with greater "downside risks to employment".

Much of the jobs slowdown was attributed to reduced labour supply rather than demand weakness, with Powell citing lower immigration and workforce participation. This distinction matters for investors as it suggests structural rather than cyclical employment challenges.

Inflation remains sticky

The Fed acknowledged that goods inflation has "picked up" while services disinflation continues. Powell attributed rising goods prices to tariff impacts, noting that companies are beginning to pass increased costs through to consumers, though only partially so far.

The central bank's inflation target of 2% remains elusive, with Powell effectively conceding they won't hit this goal "anytime soon." This creates a challenging backdrop where the Fed must cut rates to support employment while inflation stays elevated.

It's another way of saying we're probably not going to hit 2% inflation amid a rather stagflationary environment.

Market volatility

The S&P 500 was trading around breakeven heading into the rate decision, and briefly up 0.25% on the rate cut announcement. When Powell started speaking at 4:30 am AEST, the market dipped into negative territory, down as much as 0.8% before rallying back up to breakeven.

S&P 500 intraday chart (Source: TradingView)

Bond yields also displayed similar rip-and-dip like action, but finished the session slightly higher.

The US 10-year yield rose 5 bps to 4.08%, suggesting investors are reassessing their expectations for deep rate cuts. Powell's description of this as an "insurance cut" and emphasis on data-dependent policy suggests more uncertainty ahead.

US 10-year yield chart (Source: TradingView)

Despite the volatility, there was a clear rotation away from tech and growth, and into defensives and small caps.

• Sectors like Financials (+0.96%), Staples (+0.90%), Materials (+0.36%) and Utilities (+0.29%) outperformed

• The Dow briefly rallied as much as 1.10% to fresh all-time highs, finished the session up 0.57%

• The Russell 2000 briefly surged 2.09% to a near record high but finished the session up just 0.18%

History stays bullish

The S&P 500 delivered one of its most impressive runs in recent history, rallying over 30% since early April. But history says big rallies tend to see further gains, and so do Fed rate cuts when the market is near all-time highs.

According to Goldman Sachs, there have been only six instances since 1975 where the S&P 500 rallied more than 30% over five months. In every single case, the momentum continued, with the index posting an average gain of 18.1% over the following twelve months.

JPMorgan also noted that the Fed has cut rates while equity markets traded within 1% of all-time highs on 16 separate occasions. Each time, the S&P 500 was higher a year later, delivering average returns of nearly 15%.