Historically, the Fed's policy meetings have tended to be predictable because policymakers have communicated their intentions in advance. But this time is different, although the interest rate cut has been certain, but according to the traditional way of cutting interest rates by 25 basis points, or taking an aggressive 50 basis point rate cut, there is a big controversy.
Just after the release of United States CPI data last week, Nick ·Timiraus, a well-known macro journalist known as the "mouthpiece of the Federal Reserve", wrote that the Fed is likely to cut interest rates by 25 basis points.
However, on Tuesday local time, on the eve of the release of the Federal Reserve's interest rate decision, Timmy Laos once again pointed out that the Federal Reserve will definitely cut interest rates this week, but whether it will be a larger 50 basis points or the traditional 25 basis points has not yet been determined, and this suspense is left until the last moment.
Fed funds futures traders are currently pricing in a roughly 63% chance of a 50bp rate cut. Judging from the recent trend of U.S. bonds and the U.S. dollar, the possibility of a sharp interest rate cut is entirely real, the U.S. dollar index continues to hover at the low point of the year, and the U.S. Treasury yield is also declining.
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On the other hand, if the Fed ends up cutting interest rates by 25bp, many may be disappointed, which is a big risk for the market.
"I want them to cut rates by 50 basis points because rates are so high at the moment, but I doubt they're going to cut rates by 25 basis points," said Mark Zandi, chief economist at Moody's Analytics. "They have completed the task of full employment and inflation back to target, which is inconsistent with the funds rate target of around 5.5%. So I think they need to normalize interest rates quickly, and there's a lot of room to do that. ”
The Federal Reserve is expected to announce its first interest rate cut in four years on Wednesday (Thursday at 2 a.m. Beijing time), a move that will have a wide repercussion in global financial markets, with global investors and rate-setters seeking guidance from the Fed.
The Fed's benchmark interest rate, which is currently at a 20-year high of 5.25%-5.5%, will depend on how Fed Chair Jerome Powell leads Fed officials through a series of carefully balanced calculations.
Fed officials often refer to their job as risk management, for example, to ensure that they weigh the risk of rising inflation against the risk of accelerating unemployment. They often set interest rates to deal with more costly risks. For much of the past two and a half years, as inflation has soared above 7%, risk management departments have tended to take more aggressive measures to prevent inflation from becoming entrenched.
Over the past few days, the market has debated whether the Fed will cut interest rates by 25 basis points or 50 basis points, which has created unusual uncertainty for the market.
Judging from the current market situation, institutional analysts seem to be less concerned about the economy as a whole than the futures market, and are more confident that the Fed has time to gradually cut interest rates. Many analysts believe that the September rate cut is to maintain a soft landing for the economy, and only a few believe that it is too late.
"Economic growth in 2024 will be faster than expected, and the Fed has time to lower interest rates at a modest pace," said Michael Inglund of Action Economics. "While economic risks are imminent, the upcoming Fed rate cut will be closer to a 'mid-cycle correction' trend, as it was in 1995, 1997 and 2019, rather than the end of a cyclical recession."
The Fed's choice will be influenced by quarterly economic projections that show officials' expectations for the level of interest rates at the end of the year. While these projections are not the result of the committee's deliberations, they are generally just as important to financial markets, as policymakers' interest rate outlook could affect a range of borrowing costs for mortgages, car loans, and corporate debt.
The September projections are particularly informative, as the remainder of the year is limited to two meetings scheduled in November and December, which provide unusually specific input to the decisions of those meetings.
25bps rate cut //
The rationale for a smaller 25bp cut is based on different considerations, including sound economic fundamentals or the risk that cutting rates too quickly could trigger a return to inflation. With considerable uncertainty about what the Fed will do at this week's meeting, the latest data suggests that the Fed will cut rates more gradually than the market currently expects.
Economic data over the past few months show that inflation has returned to a steady decline to the Fed's 2% target. But the labor market has cooled, with the unemployment rate rising slightly to 4.2% in August from 3.7% at the end of last year. Average monthly wage growth slowed to 116,000 in the three months to August, down from 212,000 in December 2023. As a result, Treasury yields are also falling.
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Most economists or analysts currently expect the Fed to cut rates by 25 basis points, with a small number expecting a 50 basis point cut. But the futures market is pricing in a much greater probability of a 50bp rate cut. As time goes on, forecasts for the Fed's interest rates will diverge wider, which is bound to create a lot of uncertainty for the market.
John Donaldson, head of fixed income at Haverford Trust, said: "The equivalent of eight 25 basis point rate cuts at six meetings is very likely." "This prediction is more of a hard landing than a soft one."
Barry Knapp of Ironsides Macroeconomics said: "We think the FOMC will either under-promise, or under-deliver, or both."
However, market forecasts for the unemployment rate did rise slightly. Compared to the current unemployment rate of 4.2%, many believe that the unemployment rate is expected to be 4.4% this year and 4.5% next year, respectively.
50bps rate cut //
Until last week, investors were expecting only a 25 basis point rate cut, as few officials publicly called for further sharp rate cuts. But Fed Governor Christopher Waller said after the release of the latest jobs report on September 6: "I have strongly advocated an early rate hike in 2022 when inflation accelerates, and I would support an early rate cut if appropriate."
On the same day, New York Federal Reserve Bank President Williams said the latest data showed a sign of a continued cooling of the United States economy.
Not everyone thinks the Fed has time. William English, a former senior adviser to the Federal Reserve, said: "For them, the key issue at this meeting is their sense of risk balance." "If you're more worried about growth and employment than about inflation right now, then you're likely to want to take a little bit of insurance," he said, cutting interest rates by 50 basis points.
Diane Swank, chief economist at KPMG United States, said: "Powell's legacy depends on whether he can achieve a soft landing after the rate hike in 2021 is too late. The chances of achieving a soft landing are shrinking. ”
Neil Dutta of Renaissance Macro Research dismissed criticism that a 50 basis point rate cut would spook markets, saying there was a real risk if the Fed cut rates by just 25 basis points.
Robert Kaplan, who served as president of the Federal Reserve Bank of Dallas from 2015 to 2021, said it would be appropriate to start a rate cut cycle of 50 basis points in terms of recession risks.
Kaplan, who is now vice chairman of Goldman Sachs, said that given the current state of inflation and unemployment, the Fed's benchmark interest rate should be about 1 percentage point lower than it is now. He said the Fed should avoid further economic weakness, forcing the Fed to cut interest rates faster or more aggressively.
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