It should have been solved by now.
It’s almost certain that the Federal Reserve will lower interest rates when its policy meeting ends on Wednesday, but it’s still not clear how much it will lower rates. Futures traders in Fed funds have put in a very close call between a normal cut of 25 basis points and a huge move of 50 basis points.
People aren’t sure if a big rate cut would make investors nervous or calm them down. They are worried that an economy that is already slowing down could suddenly go into recession, which would ruin corporate earnings and end a two-year bull market.
Kathy Jones, chief fixed-income strategist at the Schwab Center for Financial Research, told MarketWatch in a phone interview that buyers usually knew how much rates were likely to change before the Federal Reserve met. This has been true for at least ten years. This time around, things are much less clear.
Jones said, “That being said, this fixation on 25 or 50 basis points is getting a little crazy.”
Fed-funds futures traders put in a 47% chance of a 50 basis point cut on Friday afternoon. This was up from 28% on Thursday. The CME FedWatch Tool showed that there was a 53% chance of a 25 basis point cut.
They have planned for cuts of 100 basis points, or 1%, by the end of the year. The Federal Reserve will only meet three more times in 2024, the next one being this Wednesday. This means that at least one of those meetings is likely to include a 50-basis-point rate cut.
People are worried that big rate cuts have only happened in very bad situations in the past. But Jones said it’s not clear that a 50-basis-point move on Wednesday would make people think the Fed knows something that investors don’t. As it stands, the fed-funds rate is now between 5.25% and 5.5%, and inflation is running at 2.5%. This means that officials have a lot of room to start cutting rates without getting inflation back up.
Jones said, “I’m in the group that says, why wait?” “At least we get to a fed-funds rate below 5%, which is still pretty tight monetary policy,” says the report.
She said that what will really set the tone for the markets is what the Fed and Chair Jerome Powell say about how big and how many more rate cuts they expect to make after Wednesday’s decision.
A 0.5 percentage point cut along with a signal that more cuts will come in 25 point amounts through the so-called dot plot forecast, which shows what rate hikes each policymaker thinks will happen, would give people peace of mind. It would also be helpful if Powell said again that the Fed could cut rates quickly because policy is still quite tight and inflation has dropped faster than expected.
A normal 25-basis point cut is more likely to scare investors who think the Fed has kept rates too high for too long, said Charlie McElligott, managing director of cross-asset strategy at Nomura, in a note on Friday.
“Anything but 50bps will [disappoint] market pricing, hence acting to tighten [financial conditions] in de facto ‘hawkish’ fashion,” he wrote. This is because fed-funds futures traders are still pricing in a big move as a strong possibility.
Some market veterans, on the other hand, say that if the Fed makes a big move at the start of a monetary easing cycle, investors will be confused about what risks officials think the economy faces.
According to a note by Nicholas Colas, co-founder of DataTrek Research, the Fed has started each of the five easing cycles since 1990, when rate choices became much more clear. The policymakers have cut rates by half a percentage point twice right away.
The first one happened in 2001. As the dot-com bubble burst, business and consumer spending slowed even more. At the same time, it was clear that the economy was starting to shrink. The second time was in September 2007, when U.S. stocks were close to all-time highs but the housing market was showing signs of trouble that would lead to the worst financial crisis since the Great Depression.
Coles said that Fed Chair Jerome Powell and other policymakers “certainly know this history.” “It’s likely that their first cut will be 25 basis points.”
After that, they will be able to do whatever they need to, but “they will likely be wary about 50 basis point cuts unless labor market conditions quickly worsen,” he said.
In a note released on Friday, Kathleen Brooks, research director at London-based brokerage XTB UK, added another possible negative factor for the market: “A 50bp rate cut next week would be a gutsy move. However, if the Fed signal that they will front load rate cuts, then it could see fewer rate cuts down the line, which could catch the market off guard and weigh on risk sentiment.”
There are clearly a lot of different ideas about what the Fed will probably do on Wednesday and how the market will react. A lot will depend on how the Fed explains its decision and what it plans to do next.
There is still some doubt about how much of a rate cut to expect because recent economic data that buyers thought would settle the issue wasn’t very clear-cut.
In late August, Powell made it clear in a speech in Jackson Hole, Wyoming, that the Fed’s top goal is now stopping the job market from getting even worse. Because of this, many analysts thought that the August jobs report on September 6 would give them an immediate answer on the size of the cut. Instead, the report was in a “gray zone” because the payrolls rise was not as strong as predicted and the unemployment rate went down.
On Wednesday, the August core consumer price index reading was a little higher than projected. This made people’s hopes for a 0.5 percentage point cut fall by a large amount. Analysts said that a Wall Street Journal story published on Thursday that talked about how policymakers are still not sure whether to start big or small seemed to give the big rate-cut bets new life.
Stock market buyers, on the other hand, have gotten over a lot of their early September sadness in the last week, thanks in large part to a sharp recovery in the technology sector. The S&P 500 SPX 0.54% rose 4%, bringing the U.S. large-cap benchmark’s September drop to 0.4%. The Dow Jones Industrial Average DJIA 0.72% rose 2.6% for the week. Nasdaq Composite COMP 0.65%, which is mostly made up of tech stocks, gained 6% this week, bringing its month-to-date drop to 0.2%.
For investors, it might be best to ignore the arguments about how much of an interest rate cut to make and instead focus on the fact that a rate-cut cycle is about to begin. Depending on the state of the economy, this has been both good and bad for stocks in the past.
“What’s important is that we know where interest rates are going,” Jones at Schwab said. “To plan your investment horizon, it’s enough to know that prices are going down.”
