The Federal Reserve is set to make a significant move this Wednesday at its Federal Open Market Committee (FOMC) meeting: a cut to the federal funds rate for the first time in over four years. While the size of the cut is still up for debate, the meeting is generating considerable buzz. The two key options on the table are a 25-basis-point cut or a more aggressive 50-basis-point cut. As of Monday morning, the scales seem to be tipping towards the larger cut, fueled by investor sentiment and recent media articles.
Market participants are leaning heavily towards the 50-basis-point cut. According to CME Group’s FedWatch tool, Fed futures are pricing in a 65% probability of this larger cut. This is a stark contrast to just a week ago when the probability was a mere 30%. Betting markets tracked by Polymarket are echoing this trend, assigning a 58% chance of a half-point cut, up from a paltry 9% last Thursday.
This shift in market expectations can be attributed to recent media reports suggesting a closer-than-expected call on the cut. Wall Street Journal reporter Nick Timiraos and Bloomberg Opinion columnist Bill Dudley have played key roles in driving this sentiment. Timiraos’ article highlighted the FOMC’s internal deliberations, raising the question of whether to opt for a traditional 0.25 percentage point cut or a more substantial 0.5 point reduction.
Dudley, a former president of the Federal Reserve Bank of New York, presented a compelling case for a 50-basis-point cut, arguing that the Fed’s dual mandate – maintaining price stability and maximizing sustainable employment – is now better balanced. This suggests a neutral monetary policy, but current short-term interest rates are significantly above neutral. Dudley believes this disparity should be quickly corrected with a larger cut.
However, not everyone is convinced about the need for a larger cut. Analysts at Bank of America and Goldman Sachs are predicting a more modest 25-basis-point reduction. Mark Cabana, CFA and Bank of America rates strategist, expects the September FOMC meeting to result in a 25-basis-point cut. Cabana notes that Fed officials did not signal a larger cut before the blackout period, and recent U.S. inflation data has been relatively firm.
Cabana expects a neutral to dovish tone from the FOMC, forecasting 75 basis points of cuts in 2024, with two additional 25-basis-point reductions in November and December.
Goldman Sachs economist David Mericle shares a similar view, predicting a 25-basis-point cut. Mericle believes a larger cut would be “somewhat out of keeping with usual Fed practice,” reserved for times of crisis or significant spikes in unemployment. Assuming a 25-basis-point cut on Wednesday, Mericle expects the median dot plot to indicate three additional 25-basis-point cuts in 2024, followed by quarterly cuts thereafter.
The Federal Reserve’s decision on the rate cut will have far-reaching implications for the economy, financial markets, and businesses. This week’s FOMC meeting is a crucial moment for the Fed and the country, and the market is holding its breath to see what course the Fed will chart.
