The US central bank, with its recent decision, is attempting to avoid a liquidity shortage that could be caused by excessive withdrawal of reserves from the banking system.
The Federal Reserve (Fed) cut interest rates by 25 basis points for the second consecutive meeting, bringing policy rates to their lowest range since 2022, between 3.75% and 4%. The decision was not unanimous, with two officials dissenting for different reasons. Stephen I. Miran, who joined the Fed Board of Governors last month, voted for a larger rate cut of half a percentage point, as he had done in September. In contrast, Jeffrey R. Schmid, president of the Federal Reserve Bank of Kansas, supported keeping rates at their previous levels, between 4% and 4.25%.
Economic optimism… but weaknesses remain
The Fed made its latest decision with only a partial picture of the economic situation, as the government shutdown is now in its fifth week. Aside from the September inflation report, no other economic data from government sources has been released, forcing officials to rely on alternative — and less reliable — sources of information.
In its official statement, the Fed presented a more optimistic picture of economic activity, but stressed that the labor market remains vulnerable. While acknowledging that the economy is “expanding at a moderate pace” and that unemployment remains low, it warned that “downside risks to employment have increased in recent months.”
End of quantitative tightening
In addition, the Fed signaled an imminent change in the management of its $6.6 trillion balance sheet. Starting December 1, the bank will stop further reducing the balance sheet due to concerns about the bond markets, which are the backbone of the financial system. At its peak in 2022, the Fed’s balance sheet had reached almost $9 trillion, due to massive purchases of government bonds and mortgage-backed securities — measures taken to support the economy during the pandemic crisis. Now, the central bank is trying to avoid a liquidity shortage that could be caused by excessive withdrawal of reserves from the banking system, as happened in 2019.
Powell is enigmatic about the Fed’s next steps – Fear of crisis, signal for increased liquidity
Federal Reserve (Fed) Chairman Jerome Powell appeared enigmatic and cautious in his statements after yesterday’s (29/10) decision to cut interest rates again.
Although the move received “strong and consistent support” within the Committee (FOMC), he left all possibilities open for the next meeting in December, emphasizing that “what happens next is a different matter.”
J. Powell acknowledged that the economic picture remains fragile, with inflation “slightly above target” and the labor market slowing but showing no signs of a sharp decline. “Available data suggest that layoffs and hiring remain subdued, while the deflationary trend in services continues,” he said.
Balance Sheet Focus – Shrinkage Ends on December 1
The focus of Powell’s remarks was on the Fed’s balance sheet and the management of liquidity in the banking system. The Fed chairman confirmed that the reduction of the balance sheet will “freeze” on December 1, in a decision that has “broad support” within the Committee. As he said, “there is not much benefit in keeping the tightening program active for just the last few billion dollars.” The specific date, he added, gives markets time to adjust smoothly, while allowing the Fed to avoid a potential liquidity crisis in short-term money markets, where tensions are already being observed.
Mr. Powell also made it clear that the Fed will gradually begin adding reserves to the system, signaling a shift from the contraction phase to stabilization. “At some point we will want to start gradually increasing reserves,” he said, adding that the Fed’s portfolio “is longer in duration than the outstanding Treasury securities” and that the goal is to move to shorter maturities.
The December 2025 meeting
Regarding the next meeting, he refrained from committing, saying that no decision had been made in advance on another rate cut. “Today’s cut was a risk management measure. What happens next will depend on the data and the balance of risks,” he stressed. The Fed chief acknowledged that the goal remains price stability and maximum employment, and also that committee members have “different forecasts and different tolerances for risk.”
Mr. Powell described the Fed’s monetary policy as “mildly accommodative,” noting that this level of tightening is helping to gradually cool the labor market without causing a recession. “We see no evidence that the labor market or inflation expectations are moving to levels that would make inflation more persistent,” he said.
However, he warned that the latest signs in money markets are worrying and that a high level of uncertainty “could warrant more caution” in the next steps.
In his words, Powell sent a clear but carefully worded message: the Fed fears a potential liquidity crisis or even a market collapse, and is preparing to increase reserves to stabilize the financial system, without completely abandoning the fight against inflation.
In detail, the statement of the Monetary Policy Committee (FOMC) after the two-day meeting (28-29/10):
“Available indicators suggest that economic activity is expanding at a moderate pace. Employment growth has slowed this year, and the unemployment rate has increased slightly, but remained low through August; more recent indicators are consistent with these developments. Inflation has increased relative to the beginning of the year and remains relatively high.
The Committee seeks to achieve maximum employment and inflation at a level of 2 percent over the long term. Uncertainty about the economic outlook remains elevated. The Committee is cautious about the risks to both aspects of its dual mandate and assesses that downside risks to employment have increased in recent months.
In support of its objectives and taking into account the change in the balance of risks, the Committee decided to reduce the target range for the federal funds rate by 1/4 of a percentage point, to 3-3/4 to 4 percent. In considering possible further adjustments to the target range for the federal funds rate, the Committee will carefully evaluate incoming data, the evolving outlook, and the balance of risks. The Committee decided to complete the reduction in its overall holdings of securities on December 1. The Committee remains firmly committed to supporting maximum employment and restoring inflation to its 2 percent objective.
In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of new information for the economic outlook. The Commission will stand ready to adjust the monetary policy stance if risks emerge that could hinder the achievement of its objectives. The Commission’s assessments will take into account a wide range of information, including data on labour market conditions, inflation pressures and expectations, as well as financial and international developments.”
