The Federal Reserve is about to kick off its rate-cutting cycle with a bang, if Wall Street is correct. As of Wednesday morning, market pricing has clearly shifted toward a half-point rate cut, though there's still an unusual degree of uncertainty. This week's suspense-filled Fed meeting comes as the S&P 500 is knocking on the door of record territory.
The Fed meeting, which wraps up Wednesday at 2 p.m. ET, also will feature new interest-rate projections for this year and next. A change in balance-sheet policy also isn't out of the question.
Fed Rate-Cut Odds
As of Wednesday morning, markets see 61% odds of a half-point Fed rate cut and 39% odds of a quarter-point move, according to CME Group's FedWatch tool. That marks a change from 50-50 odds over the weekend.
In a Friday morning note, Deutsche Bank economists wrote that if the odds remained closely divided through Monday, it would set up the biggest Fed meeting surprise in 15 years — no matter the outcome.
Because Deutsche Bank's economists don't think the Fed wants to risk a negative surprise for markets at this juncture, they saw a rising likelihood of a half-point move.
The odds of a half-point move had fallen as low as 15% last week after release of the consumer price index showed core prices rising 0.3% in August. However, Wall Street economists now expect the Fed's primary inflation rate, the core PCE price index, will only rise by about half that amount, partly due to its smaller emphasis on housing costs.
Quarterly Economic Projections
In addition to adjusting its key interest rate, the federal funds rate, the Fed's policy-setting committee, the Federal Open Market Committee or FOMC, will update economic projections for this year.
Market pricing now shows 92.7% odds of a full percentage point in rate cuts this year, which would lower the fed funds rate to a range of 4.25% to 4.5%. Additionally, markets see 60.7% odds of one further quarter-point cut, lowering the Fed's key policy rate to a range of 4% to 4.25%.
However, markets will focus more on what the Fed does than what policymakers think about the future, since they're often wrong. If the Fed announces a half-point rate cut, markets won't fret if policymakers only telegraph one percentage point of rate cuts this year, instead of the 1.25 percentage points that Wall Street now sees as quite likely.
Next Fed Meeting: When Is It And What To Expect
Balance-Sheet Policy
The Federal Reserve is currently reducing its portfolio of government securities, which ballooned with nearly $5 trillion in purchases during the pandemic emergency. Each month, the Fed lets up to $25 billion in Treasury securities and $35 billion in government-backed mortgage securities run off its balance sheet as they mature, rather than reinvesting the sum.
However, markets are watching to see if the Fed will adjust its balance sheet policy along with the federal funds rate. Some Wall Street firms have speculated that the Fed will end balance-sheet runoff if it perceives enough risk its employment mandate to justify a half-point rate cut.
This shrinking of the balance sheet, or quantitative tightening, can act as a slight headwind for the stock market. It creates an extra supply of bonds for markets to digest, potentially putting upward pressure on Treasury yields. Bringing quantitative to an end should be positive for the S&P 500.
Is Fed At Risk Of Falling Behind The Curve?
The dilemma for policymakers going into this week's Fed meeting is that broad economic growth appears to be holding up pretty well, but the labor market has continued to soften.
GDP tracking estimates from S&P Global last week showed that Q2 GDP growth may be revised down to 2.8% from 3%; however, Q3 GDP is on track to grow a solid 2.3%.
Yet the unemployment rate has climbed to 4.2% from 3.7% at the start of 2024, while private-sector job gains have slowed to 96,000 per month over the past three months from 155,000 at the end of 2023.
Federal Reserve Chairman Jerome Powell warned that "downside risks to employment have increased" in his annual Jackson Hole, Wyo., speech on Aug. 23. Powell drew a clear line: "We do not seek or welcome further cooling in the labor market conditions."
Yet that's just what the August jobs report delivered on Sept. 6, when net hiring for June and July was revised down by 86,000 jobs. Other new Labor Department data shows job openings falling by 560,000 over June and July to the lowest level since January 2021.
If the Fed is determined to keep the labor market from getting weaker, there's a big question over whether a quarter-point rate cut will do the trick, given that monetary policy works with a lag. Election uncertainty also could dampen business investment until firms get more clarity on future tax and tariff policy.
S&P 500
The S&P 500 fell 0.1% in Wednesday stock market action after touching an intraday high on Tuesday. Last week's 4% advance for the S&P 500 took the prize for the best performance since Nov. 3, 2023.
The S&P 500 now sits just 0.7% below its all-time closing high on July 16 and up roughly 18% for the year.
Expect Market Volatility On Fed News
Markets often whipsaw after Fed meeting announcements and Powell comments.
The Fed rate-cut uncertainty, along with policymakers' rate outlooks and other big news, raises the prospect for even-bigger market reactions Wednesday afternoon, perhaps continuing on Thursday.
Be sure to read IBD's The Big Picture column after each trading day to get the latest on the prevailing stock market trend and what it means for your trading decisions.
