The long-awaited day has arrived. In the week of the four witches, but also of the central banks, the eyes of the world financial markets are focused on Federal Reserve to Cut Interest Rates Today for the first time in four years, officially closing a phase of strong increases, the most aggressive since the 80s, to open a phase of cuts that could last a couple of years.
There are no more doubts about the cut. Since the Jackson Hole meeting at the end of August, where the president Jerome Powell has anticipated plans to ease monetary policy, the question is another: will the cut be 25 or 50 basis points? “With the exception of the Fed’s emergency rate cut in March 2020 at the start of the pandemic, there has never been such uncertainty about the Fed’s actions since 2007,” he writes. Bloomberg.
Federal Reserve Cut Forecasts
After ten rate hikes between 2022 and 2023 and several months of pause, currently, the Fed Funds benchmark rate is in a 5,25-5,50% oscillation band. And if until a few days ago everyone considered a 25 basis point cut more likely, now the ranks of those expecting a Federal Reserve much more aggressive, intending to intervene in monetary policy with a 50 point cut. “Futures markets are already fully pricing in a quarter-point cut and are now indicating almost the 70% of possibilities that the Fed could ease rates by half a percentage point,” he explains Reuters. Last week this option was offered at 15%.
The experts at ActivTrades are of the same opinion, according to whom "the probability of a reduction of 0,5% have now reached around 60%“, and the FedWatch Tool of the Cme Group, with traders firmly aiming for a 50 basis point cut: until Sunday the two options were given 50-50. From Monday instead, 59% of traders are leaning towards a half-point cut, against the remaining 41% who instead continue to bet on a cut of a quarter of a percentage point.
But there are also those who call for caution: "In Vontobel's bond boutique we are leaning towards a 25 basis point cut. The US economy has slowed significantly in recent months and the path of inflation looks much more favorable than it did at the start of the year. However, we do not see an imminent risk of a recession in the US and believe that gradual but consistent cuts would be appropriate until economic data deteriorates further,” he explains to Radiocor Carlos de Sousa, Portfolio Manager at Vontobel. A quarter-point cut is also the forecast of Xiao Cui, senior economist at Pictet Wealth Management, according to whom “The FOMC will start with a 25 basis point cut” and “rate projections will suggest a gradual pace of easing consistent with monetary policy normalization rather than a labor market rescue.”
In this context, it is also necessary to consider the forecasts for 2024: expectations are for overall cuts of 120 basis points for the current year. The numbers in hand mean that if today's cut were to amount to 25 basis points, the Fed would then have to make two consecutive cuts of 50 points. A scenario considered highly unlikely.
Fed: Pay attention to Powell's words
Many people imagine great celebrations in the markets, with a rally in the bond market and stock markets, if the Fed really decides to cut rates by 50 basis points. Yet, this may not be the case, on the contrary. Especially the Stock markets could react badly faced with a choice that until a few days ago was considered "highly improbable" The reason? According to Bloomberg, such an excessive move could indicate "a more pessimistic reading of the macroeconomic data released in the last period, which seem to foretell a recessionary phase”. “The problem,” adds Neil Shearing, chief economist at Capital Economics, “is that this is a very high bar for a big rate cut, especially early in the easing cycle. If anything, it creates the impression that central bankers have made a mistake and are behind the curve.”
Simply speaking, such a large cut could be interpreted as “recessive”, a sign of a Fed Much More Worried Than Expected for the state of the US economy.
And that's how they become the words are fundamental which will use the number one of the Federal Reserve Jerome Powell to explain the decision, whatever it is, of the US central bank. “As important as the debate between 25 and 50 will be the Fed’s communication. Will 50 basis points be the start of 50 basis points or a one-off move to start the cycle? Would a 25 basis point cut mean the bar for subsequent 50 basis points is high? There will be a lot to digest,” a group of Deutsche Bank strategists led by Jim Reid said in a note.
The latest data on the US economy
A chiaroscuro painting. The last ones could be summarized like this US economic data. Because while it is true that significant progress has been made on inflation, it is equally true that the labor market seems to be showing some signs of suffering.
The latest news arrived yesterday: the retail sales, in August, grew by 0,1% from the previous month to 710,8 billion dollars, after the +1,1% in July (revised from the initial +1%); expectations were for a -0,2%. Speaking of prices, the most recent data seem to show that inflation, which fell to 2,5% on an annual basis in August from 2,9% in July, is returning to its targets. The core figure, the one most closely monitored by the Federal Reserve which excludes the most volatile components such as food and energy, remained stable at 3,2% and in line with expectations. Also the PCE Price Index, released at the end of August, had confirmed consumer inflation at 2,6%, lower than analysts' expectations (2,7%).
But what is worrying is a labor market in slowdown, although there are still no clear signs of an impending recession. In August, the jobs – excluding agriculture – increased at the slowest pace since the end of the pandemic. Growth was in fact 142 thousand jobs, well below the 164 thousand expected by the market. However, the unemployment decreased slightly to 4,2% and the average hourly wages have increased more than expected. Faced with these numbers, some analysts continue to speak of a recession for the third quarter, despite the upward revision of the GDP of the second quarter to 2%. What will the Fed interpret? We will find out tonight.
