Written by: Zhao Ying, Wall Street News
The Federal Reserve will implement its first interest rate cut in five years tonight, and as the decision approaches, the suspense about the extent of the cut continues to escalate. Wall Street is arguing over "a 50 basis point cut or a 25 basis point cut." Market uncertainty has suddenly increased. How will the Fed's "interest rate cut journey" begin?
At 02:00 on Thursday (September 19), the Federal Reserve will announce its September interest rate decision, followed by a speech by Federal Reserve Chairman Powell at 2:30. Currently, the Federal Reserve's interest rate cut is almost a done deal, but the extent of the cut remains uncertain.
Recently, neither inflation nor non-farm payrolls have been able to "make a decision" on the extent of the rate cut, and the market is wavering between a 50% or 25% rate cut; then, during the Fed's silence period, the media "leaked" a 50 basis point rate cut, causing market expectations to shift to that camp. So far, the market is betting on a 50 basis point rate cut probability that has jumped sharply to 60%, while the probability is only 30%.
Currently, Wall Street has different opinions. One side supports a 50 basis point rate cut due to concerns about the labor market and the Federal Reserve "falling behind the curve", while the other side supports a 25 basis point rate cut due to concerns about continued inflation and retaining options for subsequent rate cuts.
However, whether it is 25 or 50 basis points, the market will probably be shaken violently. The market is now betting heavily on 50 basis points. If the Fed cuts interest rates by 25 basis points, the market will face huge losses; if the Fed cuts interest rates by 50 basis points, but the subsequent actions lag behind market expectations, it may cause panic and tighten financial conditions again.
In addition to the extent of the Fed's interest rate cuts, it is also worth paying attention to the Fed's "dot plot" and economic forecasts. This dot plot is particularly important for predicting this year's interest rate cuts; as well as Powell's speech at the press conference.
The most controversial FOMC meeting: 25 basis points "huge loss", 50 basis points "panic"
The Federal Reserve's decisions have always attracted much attention, but the content of the meetings is usually predictable, and this time the controversy over the extent of the interest rate cut reached its peak.
The recently released data is "mixed", and neither inflation nor employment data can "make the final decision" on the extent of the interest rate cut. Last Wednesday's CPI data showed that inflation is still sticky, raising the probability of a 25 basis point rate cut, while last Thursday's PPI data cooled year-on-year, slightly increasing the possibility of a 50 basis point rate cut.
Until late last week, expectations of a 25 basis point rate cut prevailed, but on Friday, market sentiment suddenly changed and the possibility of a 50 basis point rate cut was put on the table. Market sentiment was mainly influenced by the "informed reports" published by the Wall Street Journal and the Financial Times last Friday, and the Fed officials did not explicitly refute it in the subsequent market fluctuations.
Seema Shah, strategist at Principal, said:
For the Fed, it will ultimately have to decide which risk is greater, a 50 basis point rate cut that would reignite inflationary pressures, or a 25 basis point rate cut that would threaten a recession. The Fed has already been criticized for being too slow to respond to the inflation crisis, so it may be cautious in responding to recession risks and avoid taking a reactive approach rather than a proactive one.
However, whether it is 25 or 50 basis points, the market will probably be shaken violently. The market is now betting heavily on 50 basis points. If the Fed cuts interest rates by 25 basis points, it will be regarded as "hawkish" and trigger risk shocks in the market.
Analysts said that now locked in a record bet of a 50 basis point rate cut with the Fed consensus, the market would face staggering losses if officials opt for a standard rate cut. 92% of economists expect this to happen. If the Fed takes unexpected action, federal funds will be forced to reprice significantly and all asset classes will suffer.
Since last weekend, trading volumes in October federal funds futures have surged to their highest level since 1988, and more worryingly, data shows that most of these new bets are targeting a 50 basis point rate cut, with positions surging this week alone.
If the rate cut is 50 basis points, such a sharp rate cut cycle means that the economy is in trouble, but economic forecasts and corporate earnings expectations are still quite optimistic. Analysts believe that this seems to be a completely contradictory message, expecting a sharp rate cut in the United States, while expecting continued strong earnings growth. Historically, rate cuts usually lead to a 20% or more drop in reported profits, so earnings are expected to drop by more than 30%.
In addition, if the economic situation does not improve significantly, the pace of subsequent rate cuts may also be slower than market expectations. If the Fed is seen by the market as slowing down its actions, the Financial Conditions Index (FCI) will tighten again, leading to lower oil prices and lower inflation expectations, which may put upward pressure on real interest rates and push up the dollar.
The dot plot is particularly important for predicting interest rate cuts this year
Equally important as the interest rate cut is the "dot plot". Considering that the Federal Reserve will release the latest "dot plot" of interest rate trends in 2025 at this meeting, the market will seek clearer guidance from the Federal Reserve on the pace and scope of future interest rate cuts, which will also affect market performance in September to a certain extent.
David Wilcox, who led the Federal Reserve’s Research and Statistics Department and is now director of U.S. economic research at Bloomberg Economics, said:
The year-end dot plot is now particularly important and is obviously more closely watched because the Fed is on the brink of starting a rate-cutting cycle.
Specifically, the dot plot will show differences of opinion within the FOMC, such as how many members favor further rate cuts in November and December, especially if a large number of members prefer to further cut interest rates by 50 basis points before the end of the year, which will indicate that the Fed may take more aggressive actions in the future.
The release of the dot plot will have a direct impact on the market's pricing of interest rates. Since the disappointing July jobs report in early August, traders have been betting on a full hundred basis points of rate cuts by the end of this year.
If the dot plot shows that more members support a larger rate cut, the market may adjust asset pricing accordingly, pushing market expectations further downward.
If the "dot plot" released this time shows that the median forecast of the policy interest rate returns to the level of March or lower, it will mean that the Federal Reserve's monetary policy stance is more dovish.
In addition, the Fed also releases forecasts for unemployment, GDP, and inflation data.
Analysts predict that the biggest adjustment in September may be related to the unemployment rate. The Fed will almost certainly raise the unemployment rate from 4.0% in June to 4.2% now. Inflation expectations may be lowered, with full-year core inflation expected to be 2.8% in June and 2.6% in July.
Goldman Sachs said in a report that inflation appears to be lower than the FOMC's June forecast, and the rise in inflation at the beginning of the year looks more like seasonal factors than a reacceleration, so a key theme of this meeting will be to shift the focus to labor market risks.
What will Powell say?
In addition to adjustments to the dot plot and economic projections, the FOMC’s post-meeting statement will also inevitably be revised to reflect the expected rate cuts and other forward guidance from the committee.
Goldman Sachs predicts that the FOMC may modify its statement to something like:
It was more confident about inflation, described inflation and employment risks as more balanced, and reiterated its commitment to maintaining full employment.
Jefferies economist Thomas Simons said:
I don't think they're going to be particularly specific about giving any forward guidance, which is of little use at this stage in the cycle when the Fed doesn't actually know what they're going to do.
