After muscling interest rates at a pace not seen since the Walkman was cutting-edge tech, the Federal Reserve has finally reversed course.

The Fed on Wednesday announced its decision to slash its benchmark federal funds rate by a whopping 50 basis points (0.50%). That’s a remarkable pivot from the long-prevailing monetary policy.

In March 2022, the Fed embarked on its most aggressive tightening campaign in 40 years, to fight COVID-induced inflation. However, inflation is edging back toward the Fed’s 2% target and the central bank is now taking a longer, more worried glance at employment.

According to Fed Chair Jerome Powell at his press conference yesterday, this move is all about staying ahead of the curve and pursuing the Fed’s dual mandate of maximum employment and price stability.

Wednesday’s cut marks the beginning of what looks to be a slow, deliberate retreat from the restrictive rate policies we’ve endured.

The federal funds rate currently hovers at 4.75%-5.0%, down from the prior range of 5.25%-5.5% (see chart).

The Fed’s latest “dot plot” suggests that more rate cuts are on the horizon—two this year, four in 2025, and two more in 2026, bringing the rate down to a so-called “neutral” 2.9%.

With each cut, Powell and his colleagues signal to the markets that they’re optimistic about keeping growth steady and inflation contained. They’ve even adjusted their unemployment forecasts, expecting it to peak at 4.4%, a slight revision upward.

Despite Wednesday’s surprisingly hefty rate reduction, the Fed continues to peddle the narrative of a “soft landing,” justifying a cautious, step-by-step approach to loosening monetary policy over the coming years.

The age-old lesson for investors is that the market’s reaction to rate cuts depends on the broader economic context. Historically, when the Fed cuts rates while a recession isn’t lurking, equity markets tend to thrive, with gains emerging over the following 12 months. On the flip side, if rate cuts are seen as a last-ditch effort to stave off economic collapse, losses have typically followed.

This time, though, the Fed seems to be cutting rates not because the economy is in peril but simply because it has the elbow room to do so.

Partisan bloviating…

Of course, as you’d expect in our hyper-partisan age, some politicians immediately starting whining that the Fed was making a politically motivated move to juice the economy and thereby help the incumbent Democrats in the forthcoming election. But those accusations are hogwash.

Critics who claim Wednesday’s rate cut constitutes a conspiracy against the GOP seem to forget that Powell is a registered Republican who was appointed by Donald Trump. Powell has long demonstrated his inherently conservative and non-biased nature. The Fed Chair and his colleagues make decisions based on the data.

Besides, economic growth already has shown resilience. Recent economic data, such as robust retail sales and strong industrial output, have prompted the Atlanta Fed to revise its U.S. gross domestic product (GDP) growth forecast for the third quarter from 2.5% to 3.0%.

Consumer spending remains strong and the uptick in unemployment stems from a larger workforce, not a surge in layoffs. This suggests that the economy might, just might, achieve the fabled soft landing.

As long as the economy avoids plunging into recession, I expect the bull market in stocks to roll on, albeit with a few bumps. Cyclical stocks and those trading at lower valuations should begin to catch up with the high-flying tech giants.

Meanwhile, in the bond market, the prospect of lower rates has historically led to positive returns in investment-grade bonds, a trend I expect to see again. However, with rates likely to continue their slow, steady descent, short-term cash investments face reinvestment risks, making longer-term bonds more attractive.

On Thursday, the main U.S. stock market indices soared as investors digested the Fed’s rate cut and became euphoric. The trading session’s final tally:

• DJIA: +1.26%
• S&P 500: +1.70%
• NASDAQ: +2.51%
• Russell 2000: +2.10%

The S&P 500 hit a new record high. Mega-cap tech stocks led the gainers, notably: Nvidia (NSDQ: NVDA) +3.97%; Apple (NSDQ: AAPL) +3.71%; Tesla (NSDQ: TSLA) +7.36%; Meta Platforms (NSDQ: META) +3.93%; and Advanced Micro Devices (NSDQ: AMD) +5.70%.

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John Persinos is the editorial director of Investing Daily.

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