Wall Street has largely convinced itself that a much-anticipated rate cut is coming this week. The general consensus is that on Wednesday Fed Chair Jay Powell will announce a 25 basis point (bps) cut following the Federal Open Market Committee (FOMC) meeting—though experts are warning if analysts get a surprise, it may bode badly for the stock market.
Powell and his colleagues on the FOMC have been open about their shifting views on the economic landscape.
They believe that inflation—which peaked during the pandemic—seems to be heading sustainably back down towards the target rate of 2% meaning the FOMC can instead turn its attention to employment, the second half of the organization's dual mandate.
While the FOMC can never make promises ahead of time, the Street has picked up on this change in tone and drawn their own conclusions.
As a result, many banks are now pricing in a cut of 25bps, the smallest increment by which the Fed typically adjusts interest rates.
Pricing in such a cut has far-reaching consequences. It means the Street can prepare for potential increases in corporate and consumer borrowing as the practice becomes cheaper.
Likewise it means analysts have some confidence that the Fed is focussed on maintaining a certain level of employment and productivity.
As such, economic activity could be reasonably expected to increase—putting fears of a recession more firmly in the rear view and a so-called soft landing on the cards instead.
But…50bps?
Some institutions are questioning whether a larger cut—of 50bps—might be announced this week, though others are fearful this may create a yoyo effect with inflation, sending it higher just as it seemed to be coming under control.
Mark Haefele, chief investment officer at UBS Global Wealth Management wrote in a note this morning: "In our view, overall inflation data has been good enough to allow the Fed to start cutting rates this week amid a softening labor market, but do not give officials a reason to cut aggressively.
"Data for retail sales and industrial production due Tuesday could potentially influence the Fed’s decision, with weak results likely to trigger a 50-basis-point cut."
The note seen by Fortune adds: "As Fed Chair Jerome Powell pointed ... while the timing and pace of rate cuts will depend on incoming data and the balance of risks, 'the direction of travel is clear.' In our base case scenario of a soft landing, we see room for 100 basis points of interest rate reductions this year, and another 100 basis points in 2025."
Not too hot, not too cold
While Bank of America says it is reading the "data, not the tea leaves," it too is convinced that a cut is coming following the meeting tomorrow and Wednesday.
An outside chance of there being no cut (as has been the case for the past four years) isn't mentioned in a Friday note penned by U.S. economists Aditya Bhave and Stephen Juneau, who had locked in a predicted September rate cut back in August.
"Our base case is still gradualism," the duo wrote. "We think a lack of conviction is warranted at turning points in the cycle such as this one."
The duo write that a softening labor market will be propped up by a resilient consumer, and as such BofA is forecasting a "methodical" cutting cycle of 25bps in every meeting through to March 2025.
And while a 25bps cut is now not only hoped for but expected, experts have also warned that should Powell come out of the blocks more aggressively this could panic investors.
As David Smith, Rockland Trust chief investment officer, told CNBC earlier this month: "I'm actually a little concerned if they did something more aggressive and moved as much as 50bps because I'm concerned that the market participants may view that as the Fed seeing something scary in their economic data and are moving aggressively to get in front of that."
This concern is plain to see. Last week Thierry Wizman, global FX and rates strategist at Macquarie wrote that for a 50bps cut to occur it would require a financial crash to happen ahead of the meeting.
