This week, there was a sense of rare mystery surrounding the Federal Open Market Committee (FOMC) meeting of the Federal Reserve. Despite the market collectively anticipating a rate cut by the Federal Reserve, there was disagreement on the extent of the cut.
The Fed meeting took place from Tuesday (September 16) to Wednesday (September 17), and the Federal Reserve is scheduled to announce its statement and economic forecasts at 2 p.m. Eastern Time, followed by a press conference by Federal Reserve Chairman Jerome Powell at 2:30 p.m.
Market expectations for a rate cut by the Federal Reserve have changed significantly over the past two weeks. Initially, traders in the market were focused on a 25 basis point cut. However, by Friday of last week, sentiment shifted abruptly, with equal possibilities of a 50 basis point and 25 basis point cut. As of Tuesday afternoon, federal funds futures traders were pricing in a 63% chance of a 50 basis point cut.
Nevertheless, CNBC’s survey of Wall Street insiders indicated that many still predicted the Fed would opt for a more cautious 25 point cut as the initial step.
Here are some highlights worth noting after the Fed meeting on Wednesday:
Will the Fed take the traditional 25 basis point rate cut approach or be more aggressive with a 50 basis point cut?
Mark Zandi, Chief Economist at Moody’s Analytics, told CNBC, “I hope they cut by 50 basis points, but I doubt they will. The current rates are too high. The Fed has achieved full employment and inflation is back to target levels, so there is room to quickly normalize rates and cut them significantly.”
Since the last rate hike in July 2023, the Federal Reserve has maintained the benchmark federal funds rate between 5.25% and 5.5%.
This is the highest level in 23 years. Currently, the Fed’s favored inflation gauge has dropped from 3.3% to 2.5%, and the unemployment rate has increased from 3.5% to 4.2%, providing justification for the Fed to start cutting rates in September.
Several Fed officials, including Powell, have publicly indicated in recent weeks that a rate cut in September is likely. The extent of the rate cut will depend on officials’ weighing of various factors.
If the Fed is more concerned about growth and employment than inflation, they are likely to opt for a more cautious approach, possibly with a larger 50 basis point cut.
A smaller 25 basis point cut would imply the Fed considers the economic fundamentals to be strong and is wary that cutting rates too quickly could fuel risk appetite, resulting in persistently high inflation.
In the past, Fed officials have tended to hike or cut rates by 25 basis points. However, when they find their rate stance misaligned with risk balance, they may act more rapidly. Fed officials previously raised rates in 2022 by 50 and 75 basis points to combat high inflation.
Equally important as the rate cut is the dot plot released by the Fed after the meeting, revealing officials’ expectations for future rate movements.
CNBC noted that the two-day FOMC meeting debates would be interesting, given the unusual divergence among officials, who typically maintain consensus.
Former Dallas Fed President Robert Kaplan told CNBC on Tuesday, “I suspect they don’t all agree.”
Kaplan stated that some Fed officials, like himself, feel the move to cut rates is somewhat belated, prompting them to take preemptive action this time. However, other officials are likely to consider risk management more cautiously.
Furthermore, the dot plot to be released on Wednesday will provide the first outlook for 2027.
In June, Fed officials had only expected one rate cut by the end of the year. It is almost certain that the rate cut process will accelerate significantly, with markets expecting a total cut of up to 5 notches, or 1.25%, remaining over three more Fed meetings this year.
According to the FedWatch futures contract index from the CME Group, traders believe the Fed will significantly lower rates by 2025, accumulating a decrease of 2.5%.
The Fed’s economic forecasts, including unemployment rates, Gross Domestic Product, and unofficial inflation forecasts, will also be revealed on Wednesday.
Economists at Goldman Sachs stated in a report, “Inflation is expected to be lower than the Fed’s June forecast, with the earlier elevated forecasts looking more like residual seasonality than a reacceleration. Therefore, a key theme of the meeting will be shifting focus toward labor market risks.”
Tom Simons, an economist at Jefferies, said, “While tightening policy seemed to work, it did not work as well as they had imagined, so loose policy should also be viewed with the same uncertainty.”
“Therefore, if the Fed is unsure, it should not rush (to cut rates),” added Simons.