The Fed’s aggressive 50 basis point (bp) rate cut suggests three major consequences, each of which could have bearish effects on the U.S. bond market, which serves as a benchmark for global assets. Let’s look at those.
Implication 1: Redefining the Inflation Target
The most prominent consequence is that the Fed has effectively shifted its approach to inflation. Historically, the Fed maintained a 2% inflation target, but recent developments have transformed this target from a ceiling into a floor. From 2009 to 2020, the annual core Personal Consumption Expenditures (PCE) inflation rate only exceeded 2% for one month, and during the prior period from 1994 to 2008, the mean PCE inflation was 1.89%. However, the current environment indicates that the Fed is now aiming for a 2.4% minimum level of Consumer Price Index (CPI) inflation, due to a consistent structural difference of 41 basis points (bp) between CPI and PCE inflation measures. Over the course of an economic cycle, inflation is expected to average around 2.9%.
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