The FOMC is expected to cut rates for the first time since the 2020 Covid-induced recession. This news has already been priced into the financial markets. The two main issues remain unclear and worth following:
First, how much they will cut? Since the Fed has acted slowly in the past, the likely scenario is a 25 bp rate cut. However, the bond market gives a 60% chance that the Federal Reserve will slash rates by 50 bp. This 50 bp cut is possible as the recent CPI report showed headline CPI came in line with expectations – even though core CPI was slightly above expectations – and still shows a downward trend while the labor market continues to cool down. If the Fed were to cut rates by only 25 bp, that could disappoint markets again and may lead to a market tantrum, as we saw back in late July.
Table: Target rate probabilities for 2024-2025
Second, even if the market is correct and the FOMC cut 50 bp, financial markets will also react to the outlook for future rate cuts. They expect a rate cut of 25 to 50 bp for each meeting for the rest of the year. But suppose the FOMC were to accommodate the market and slash rates by 50 bp. In that case, it will most likely be accompanied by a “wait and see” view that could disappoint them, considering they expect a dovish FOMC statement. The economic outlook and Chair Powell’s press conference could provide additional insight into what to expect in the upcoming policy events.
The possible upside for the markets if the FOMC only cuts rates by 25 bp is that it may provide a more dovish outlook for future rate cuts, which, as always, will be data-dependent but could be more in line with the current bond market outlook. So, a jam-packed meeting indeed ahead that could shape the future path of financial markets for the next few weeks running up to the US presidential elections.