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The Federal Reserve is poised to deliver its first interest rate cut since 2020 on Wednesday a move that consumers, businesses and investors alike have been eagerly awaiting.

A rate cut would mark the end of the central bank's policy of pushing up borrowing costs to subdue the inflation that surged out of control starting in 2021. Forecasters and financial market participants anticipate the Fed's policy committee will reduce the influential fed funds rate by at least a quarter percentage point from its current range of 5.25%-5.5%, where it’s been held since July 2023.

Fed officials have signaled that rate cuts are coming, and the open question for the past several months has been how big they will be. Some recent comments from Fed officials, as well as economic data showing some lingering inflation in the housing market, have indicated that the central bank could opt for a more conservative quarter-point cut rather than the half-point cut that some experts say could be on the table at the meeting.

"In this environment, I don't see why the Fed would go crazy by cutting rates 50 basis points," said Maxime Darmet, a senior economist at Allianz Trade, a Paris-based financial company. "I think there's no rush."

However, a larger cut is far from out of the question. Financial markets were pricing in a 61% chance of a half-point cut midday Tuesday, according to the CME Group's FedWatch tool, which forecasts rate movements based on fed funds futures trading data.

In addition to setting the fed funds rate, Fed officials will make economic projections about how fast and how far they will cut rates in the years and months ahead.

The End Of An Era

The rate cut would be the first reduction of the fed funds rate since the Fed chopped it to near zero when the pandemic hit in March 2020. The cut would close a chapter in the Fed’s monetary policy that has profoundly affected the financial lives of Americans. The Fed’s campaign of interest rate hikes, which began in March 2022, has pushed up borrowing costs on all kinds of debt, including mortgages, credit cards, and car loans.

At the same time, inflation has fallen from its highest level in over 40 years to near pre-pandemic levels. The cost of living, as measured by the consumer price index, was up 7.1% over the year in June 2022 as measured by Personal Consumption Expenditures, the Fed’s preferred standard. Since then, it’s fallen to 2.5%. Inflation could fall to the Fed’s goal of a 2% annual rate as soon as September, according to a forecast by Oxford Economics.

The high interest rates were meant to subdue inflation by discouraging borrowing and spending and allowing supply and demand to rebalance. However, they’ve also dragged on the economy and hurt the labor market. With business loans costlier, and consumers less able to borrow, employers have curtailed hiring.

Labor Market Cooling in Focus as Inflation Falls

The unemployment rate has ticked up this year fast enough to set off a historically reliable warning that a recession is imminent, although the overall rate isn’t yet high by historical standards.

The Fed is mandated by Congress to keep both unemployment and inflation at low levels. Its primary tool for doing so is the fed funds rate, which sets the costs that banks pay to borrow money, with far-reaching ripple effects through the financial system.

Fed Chair Jerome Powell and other officials have acknowledged in recent months the progress that's been made in taming inflation, while expressing increasing concerns about the weakening of the labor market.

The fact that inflation has fallen back nearly to normal levels without a crash in the labor market is a historical rarity. In previous episodes where the Fed has raised interest rates sharply to subdue inflation, recessions and mass unemployment have followed.

The central bank's success this time around validates the Fed's policy of inflation targeting, which has been the subject of debate among economists, Allianz's Darmet said. The Fed's insistence that it would get inflation down to 2% has become a self-fulfilling prophecy because people believe it, and make financial decisions accordingly. For example, if people believe inflation will be high, they might rush to make major purchases before prices go up, which in turn could boost demand and allow merchants to raise prices faster. But if they believe inflation is going to be low, they might not be in such a hurry.

"If people believe they're very serious about 2%, you get the 2% inflation at the end," Darmet said.

Correction, Sept. 16, 2024: A previous version of this article misspelled economist Maxime Darmet's name.