Rarely has the US Federal Reserve arrived at a meeting of its Federal Open Market Committee (FOMC) with such a pronounced dilemma. This Wednesday, the central bank of the world’s leading power to announce first interest rate cut in four years. There is no doubt about it. The big dilemma is the size of the cut: the idea of an initial 50 basis point cut instead of the traditional 25 basis points to somehow “compensate” for the high range that rates have reached and maintained (remember, rates above 5%) has crept into the debate, sowing doubt among policymakers. Even though the initial thesis was and still is a 25 basis point cut, every macro data or minimal appreciation in the economic debate tips the scales toward the “giant” cut, as analysts call the “big” 50 basis point cut. As they say, the decision is now a coin toss.
The magnitude of this reduction is significant because it would send two clear messages. On the one hand, a large telegraphic cut a more aggressive rate cut trajectory by a Fed that has publicly acknowledged that it is once again, in its dual mandate, more concerned about the labor market than about inflation. On the other hand, this implies some “regrets” from the central bank for not having removed them earlier and having allowed, for example, the labour market to deteriorate more than necessary.
Proponents of a “standard” 25 basis point reduction argue that a ‘jumbo’ drop would convey a certain feeling of hysteria when the labor market deteriorates but does not collapse and the economy has not yet succumbed. GDP growth in the first half of 2024 continues to show notable resilience and surprised with growth of 0.7% quarter-on-quarter (3% annualized) in the second quarter and 0.4% in the first (1.4% annualized). In addition, the composition of growth is very positive: private consumption and non-residential investment continue to drive the economy strongly. These same “advocates” point out that the evolution of inflation paves the way for this moderate decline: disinflation continues, but the stagnation of core inflation due to housing encourages a cautious rate cut.
On the side of the defenders of the “jumbo” cuts, we regret that the Fed has left the rates at a very restrictive level for too long and which can now be paid very dearly with a declining job market and the specter of recession on the horizon and the American consumer, the real economic engine, completely exhausted and with no savings to draw on.
The last two major macroeconomic data were expected to help tip the scales, but the battle between the two continued. The August jobs report again reflected a sharp weakening in the labor market, but the numbers did not reflect the haemorrhage that some had feared, giving arguments in favor of both factions. Later, the August CPI, while recording the lowest headline figure in more than three years (2.5%), included underlying month-on-month data a tenth higher than expected (0.3%) and persistent house price inflation that once again encouraged advocates of moderate cuts.
However, as the week drew to a close, “The Man the Fed Whispers to” It changed everything. The journalist Nick Timiraos, from Wall Street Journal (WSJ), moved the market – and this is not the first time – by publishing that the debate between the members of the Fed on a normal cut and a “jumbo” cut was more pronounced than usual. The news revives the apostles of the big cut and evens the score. The words of the former Fed Bill Dudley, an authority on the subject, also contributed, justifying a drop of 50 points.
“There has rarely been so much uncertainty about the central bank’s intentions,” Edmond de Rothschild analysts write in a note. Officials “are caught between signs of economic weakness and inflation that stubbornly resists returning to the 2% target,” they add. The proof is that last week ended with a draw between the two teams (50% probability for the “jumbo” cup) and it started with the bets giving 65% chance of getting a “huge” cutA week ago, the chances of a 50 basis point cut were 30%. A month ago, they were closer to 25%.
Edmond de Rothschild: “Rarely have we had so much uncertainty about the intentions of the central bank”
Javier Molina, eToro strategist, highlights the key factor of “reflexivity” in this scenario. “The Fed is aware that market expectations influence its actions and vice versa, which can generate a chain reaction if you don’t manage communication properly“If the market expects a 50-point cut and the Fed only cuts 25, that could tighten financial conditions and cause volatility in risk asset markets,” he warns in his latest market commentary.
On the other hand, Molina continues, a 50-point cut would allow the Fed to avoid complicated decisions in November, just after the presidential elections, in a potentially very politically polarized environment. “In this sense, cutting 50 points now could give it a margin of pause in November and avoid a political and media reaction at a delicate moment,” he emphasizes.
With a 50 basis point movement, the analyst further explains, the Fed would choose to a preventive strategy to avoid being “late” and could thus better manage risks and ensure stability ahead of possible political events in November. “The question that remains open is whether the Fed is prepared to act preemptively or whether it will opt for a more gradual approach, and how these decisions will affect the investment outlook and market perception in the months ahead,” Molina said.
“Recall that, following this week’s decision, the next FOMC meeting will conclude just two days after the November 5th Electionswhile the outcome may not yet be known, and then again on December 18, the day after the electors in each state meet to formally elect the next president and vice president, or they will put a spoke in the wheels, as they fear. many. There seems to be a significant risk of some degree of civil unrest “risks Erik F Nielsen, chief group economic advisor at UniCredit Research.
“It is clear that a (long-awaited) rate cut is expected as inflationary pressures continue to fade in the US. However, a cut of more than 25 basis points seems unlikely, as while the Federal Reserve is delaying rate cuts, a larger move could be interpreted as a sign of panic. “The more likely outcome is that there will be more frequent cuts rather than deeper cuts,” said Paul Donovan, chief economist at UBS in London, who remains skeptical of the Fed’s current policymaking core. “Starting the easing phase with 50 points.” the bases would send an ultra-messageconciliatory difficult to controlcausing an even sharper fall in market prices across the Fed’s entire trajectory,” warns Gilles Moëc, chief economist at AXA IM.
“We believe that the decision is very close and that There will be FOMC members who vote for a 50% cut fundamental points. We agree that there are many reasons for this action. Business surveys paint a bleak picture of slowing activity and hiring. At the same time, the Federal Reserve’s Beige Book suggests that only three U.S. regions saw “slight” growth over the previous eight weeks—the Boston, Chicago, and Dallas Feds—while the other nine reported flat or declining output. However, the composition of the FOMC members who will vote, and some concern among them that inflation will remain stagnant, will likely lead a narrow majority to opt for a rate of 25 basis points. However, if they stick to that number, we expect Chairman Jerome Powell to take a relatively dovish stance at the press conference and leave the country. the door open to a bigger movement at some point if the data deteriorates,” says the ING team led by strategist James Knightley.
“We continue to expect the Fed to taper by 25 percentage points per quarter starting in September. With the economy holding up, we do not believe the Fed will feel the urgency to taper aggressively. Above-target inflation should also support a methodical tapering cycle,” Bank of America (BofA) strategists are firm.
Another part of point plot
“We expect the reduction to be 25 basis points, because, despite the fact that inflation is progressing on track, the service components have shown some resistance to the decline and, although the labor market is cooling, it is not collapsing. which, with a decrease of 25, would mean both its support for the labor market and its caution in the face of the persistence of service inflation,” estimates Isabela Lara White of CaixaBank Research.
“One factor that supports a 25 basis point cut is that Fed Chairman Powell tried to make unanimous decisions and we think some parts of the Fed would have needed an unexpected drop in CPI to act aggressively. On the other hand, the Fed generally does not want to disappoint markets in its rate decisions. Moreover, sticking to unanimous decisions could be very difficult given the divergent views on the appropriate policy, highlighted by the large difference in the rate forecasts of the FOMC members themselves,” introduces Elisabet Kopelman, American analyst at the Swedish bank SEB.
It is precisely at this Fed meeting that there will be a new quarterly delivery of inflation, unemployment and rate projections from Fed officials, the famous point plot or a plot of points. It is expected that Powell and others are telegraphing three 25 basis point cuts for the September, November and December meetings. this year, followed by 125 basis point cuts next year. A picture that contrasts with that of the June projections, in which the median of officials reflected a one-off rate cut of 25 basis points for 2024. The deterioration in employment, with unemployment (4.3% in July) already higher than the 4% predicted by officials. in June, has been decisive.
“This is lower than the 100 basis points for 2024 and 150 basis points for 2025 currently being priced in financial markets, but we strongly suspect that the Federal Reserve will emphasize the uncertainty surrounding the macroeconomic outlook and its willingness to show flexibility: it can do more if the data warrants it. We expect the Fed to maintain its long-term forecast for federal funds at 2.8%, after raising it to this level in June,” the ING team concludes.
“We believe that there will be 200 basis points of reductions in total (until the first half of 2026), for a terminal rate of 3.25-3.5%. Quantitative tightening is expected to end by the end of 2024, but could continue for a few more months. “Risks clearly lean toward faster reductions, with sequential rate cuts of 25 basis points as a plausible alternative scenario,” they add from BofA.
