The Federal Open Market Committee (FOMC) released its latest monetary policy statement. The decision was to lower the federal funds rate by 25 basis points, which is the same as 0.25%. There was one dissenting vote by Stephen Miran, who wanted to lower the target range by 50 basis points. Miran was just put on the Fed Board by Trump, so it is no surprise that he is trying to give Trump what he wants.
This cut was widely expected by the market. The Fed is now signaling that we should expect two more rate cuts by the end of the year. Since there are only two meetings left in 2025, this likely means 25 basis points will be cut at each meeting (late October and December).
If this holds, the Fed will have a target range of 3.5% to 3.75% by the end of the year. Meanwhile, the CPI numbers are still near 3%. Why is the Fed in a stage of lowering rates if price inflation is still running higher than the Fed’s stated target?
Monetary Deflation
While the rate cut gets all of the news, the Fed will continue its policy of reducing its balance sheet holdings. The Implementation Note states that the Fed will continue to allow $40 billion of debt to expire each month without rolling it over. That is $5 billion in Treasury securities and $35 billion in mortgage-backed securities.
There is no way that Donald Trump understands this at all. He watches Fox News and perhaps a little CNBC, and we can be rather certain that his advisors aren’t explaining to him that the Fed is deflating its balance sheet. He might not even know what this means. Trump just sees the headline news that interest rates are going lower.
To be sure, the Fed’s balance sheet reflects the base money supply. It still matters what commercial banks do with the money that is out there (whether they loan it out or keep it on reserve).
So, while one hand of the Fed shows lower rates (a looser monetary policy), the other hand shows monetary deflation (a tighter monetary policy).
As a side note, the banks are getting paid to keep money on reserve. That is how the Fed is controlling the federal funds rate. We see headlines that the Fed cut 25 basis points. Maybe someone should run a headline saying that commercial banks will be paid 0.25% less than before for parking money at the Fed.
Will This Stop a Recession?
The Fed isn’t just lowering rates to please Trump. The Fed members probably see trouble in the economy. Otherwise, why would they be lowering rates while price inflation is still above their target?
If you think the Fed’s easing of interest rates is going to stop a recession from coming, you should look at the past. It has been very common for the Federal Reserve to already be in easing mode when a recession becomes evident.
The yield curve was mostly inverted in 2023 and 2024. It has somewhat normalized. With this rate cut, the 3-month yield is finally below the 10-year yield.
While an inverted yield curve is a good recession predictor, there is typically a delay. The recession doesn’t actually show up until the yields have normalized – meaning that longer-term yields are higher than the shorter-term yields. This normalization often comes because shorter-term yields are being controlled by the Fed (i.e., being lowered by the Fed).
The process right now is actually typical of what precedes a recession. Perhaps one difference is that price inflation is still rather high. I would also argue that the asset bubble is far bigger than what we have seen in the past.
The Fed has control of the short-term interest rates right now. It is not likely to stop a recession from happening just by cutting 25 basis points at each meeting. Unless the Fed starts massively inflating like it did in 2020, it isn’t going to prevent a recession.
We haven’t even seen the Fed stop its policy of monetary deflation. Trump may not know this or understand this, but that doesn’t mean we can’t. The continued monetary deflation and the small rate cuts from the Fed are indicating a recession ahead. Investors in general don’t see this. The bond market tends to be wiser on these matters.