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Good morning everyone,

As expected, the US central bank, the Federal Reserve (Fed), cut interest rates on Wednesday (US time).

Surprisingly, it cut rates by half a percentage point (50 basis points). The decision lowers the federal funds rate to a range of 4.75%-5%.

The Fed last cut rates in March 2020, as part of an emergency response to an economic shutdown caused by the spread of Covid-19. It began raising rates in March 2022 and last raised rates in July 2023. The US rate cuts follow rate cuts in England, the European Union, and Canada.

Australia hasn't started cutting rates yet. At the Reserve Bank's (RBA) last board meeting in August, RBA Governor Michele Bullock said a near-term cut wasn't on the cards.

DISCLAIMER: This newsletter is not financial advice. It does not take into account your financial situation, is general in nature, and is for educational purposes only.

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1. Why is the Fed cutting so much?

Central banks have several mandates, one of which is price stability. So when inflation gets out of hand, they raise interest rates to fight inflation.

But they can't do that for too long. If they keep interest rates high for too long, they risk pushing the economy into recession. That's bad for employment, another mandate of central banks. So there's no hard and fast rule on how to tame inflation. It's a delicate balancing act.

Most of the time, central banks like to move steadily and slowly. They like to cut interest rates by a quarter of a percentage point.

As I pointed out last week, when the Fed cuts rates by half a percentage point, it is implicitly saying: Oops, we were wrong. Jobs growth has slowed at an alarming rate. We were too slow to cut rates and now we need to be more aggressive.

That's why a half a percentage point cut ran the risk of spooking investors.

So far, investors don't seem to have been spooked. Bitcoin was hovering around the US$60,000 mark before the announcement and then rose to around US$62,000 by Thursday afternoon (Australian Eastern Standard Time).

2. Where do we go from here?

In addition to the rate cut, the Fed also indicated how it intends to manage interest rates over the next two years. It does this through the so-called dot plot.

The graph of the dot plot shows, through a series of dots, where each of the Fed's 19 committee members believes interest rates will be in the future.

The dot plot shows the equivalent of another 50 basis points of cuts by the end of the year. With two more Fed meetings, one in November and one in December, that may mean two 25 basis points cuts or one 50 basis points cut.

The dot plot suggests another full percentage point of cuts by the end of 2025 and half a percentage point in 2026. If things play out as the dot plot indicates, the federal funds rate will fall by about two percentage points to a range of 2.75%-3% by the end of 2026.

The dot plot shows a future path for interest rates, but it's a projection based on the information currently available. If the underlying data (such as inflation and unemployment) change, the dot plot may change.

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3. Will we return to a zero interest rate policy?

If you look at the dot plot's forecast for the federal funds rate after 2026, you will see that there is little change.

This is in line with Fed Chairman Jerome Powell's comments after the rate cut was announced. We are not going back to the world of ultra-low interest rates, Powell said.

This could mean that the Fed wants to keep interest rates in the 2 to 3 percent range.

4. What role does the US election play?

The big variable in all these predictions is the US election and the impact of the outcome on the economy.

The worrying reality is that the economic plans of both Kamala Harris and Donald Trump appear to be rather inflationary.

Harris wants to subsidize first-time home buyers, which will only exacerbate house prices by stimulating demand.

Trump wants to impose sweeping tariffs on imports and cut taxes. The former would raise prices for US consumers, while the latter would stimulate spending. It's an inflationary double whammy.

In the US, the 12-month inflation rate was 2.5% in August, down 0.4 percentage points from July. But what if inflation picks up again midway through the next presidential term?

The Fed will need to leave some room for maneuver to tame inflation should it pick up again.

5. What does it mean for Bitcoin?

The bottom line is that we're now in an easing cycle where interest rates are being cut. Financial assets are about to get a tailwind, which should push prices higher. However, interest rates probably won't go as low as they did in the cheap money era.

As for the election, I pointed out last week that uncertainty is weighing on the crypto markets.

It would be easy for Kamala Harris to win the support of some of the Bitcoin and crypto people with just a few half-baked pro-crypto words. But I'm not holding my breath.

If Kamala Harris wins the election, there could certainly be short-term selling pressure in the market. On the other hand, as sentiment in the crypto industry is pretty bad around Kamala Harris, the relief could be immense if we find out that she won't try to choke the industry.

In the long run, however, the election doesn't matter. Bitcoin has gone from zero to what it's worth now, with no clear regulations and no acceptance by governments. Why should an election matter now?

Have a great weekend, everyone!

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