The markets are poised for a potentially radical reaction to the outcomes of the FOMC meeting today, which will conclude on Wednesday. That’s in part because of the major shift in expectations over the last few days. With no clear forecast for what will happen, the Fed meeting is likely to shake up the markets no matter what the outcome is.
Just a week ago, two-thirds of traders were expecting the Fed to cut by just a quarter of a point. That was in the wake of the somewhat indecisive CPI and labor data. Then, there has been no new information coming out, but the odds have practically flipped. Now it’s 67% in favor of a “double” rate cut, with the remainder saying only a quarter of a point. The only thing certain about the FOMC meeting today is that there will be a cut. But by how much, and what is signaled for the meetings after are still very open questions.
The Data Doesn’t Support the Optimism
It was July’s labor data that came out in early August that dramatically shifted the mood of the markets towards expecting strong easing by the Fed. But there hasn’t been a formal meeting since then. Even though Fed Chair Jerome Powell’s Jackson Hole speech all but said the time had come for rate cuts, there hasn’t been any formal move away from the Fed having projected just one rate cut this year.
August labor data showed slower job creation but a drop in the unemployment rate. In other words, the economy was still generally resilient, even though there were some signs of exhaustion. Inflation was also reported above target. All the things that economists would generally say meant that the Fed would go slow on the easing. And, in fact, that’s what they did say. According to the latest poll of economists conducted by Reuters ahead of the Fed meeting, they universally see only one rate cut, and no double cuts at any of the meetings this year. Though they do project three cuts in total.
What Changed the Mood?
Many analysts are pointing to an article by WSJ Fed watcher Nick Timiraus as having opened the floodgates when he suggested a double rate cut would be appropriate. Columns in the Forbes and Bloomberg followed, with former Fed official Bill Dudly calling for a double rate cut. The markets seem to believe they are foreshadowing something.
The thing is, a 50bps cut could have the opposite effect, by signaling to the markets that the Fed sees the economy is in worse condition. That could cause panic selling, particularly of overvalued assets such as AI-backed tech stocks. If that’s bad enough, it could precipitate a recession. Markets, after all, have shown to be extremely skittish lately, particularly with the drop seen in August.
What to Make of it All?
Markets have developed a habit of late to predict much more easing than what the Fed actually delivers. There is no reason to think that this will be an exception, where the market got it right and Fed officials got it wrong. After all, the last FOMC speakers before the pre-rate decision blackout didn’t provide any indication that the Fed was considering a 50bps cut at the coming meeting.
Either way, the dollar might end up gaining. With a quarter point cut, then expectations for higher rates could support the greenback. With a half point cut, fear that the Fed is behind the curve could make the dollar an attractive safe haven. Or Powell might just manage to thread the needle, cutting rates and providing just enough hints about further rate cuts down the road to keep everyone happy. We’ll see if he manages it.
