There is an overwhelming consensus among futures markets and economists that the Fed will cut rates at the end of its two-day meeting on Wednesday. The vast majority are betting on 25 bps of easing, with the disagreement being from those who argue for a 50 bps cut. This leaves open the possibility that the Fed may surprise the markets, regardless of the outcome.
On top of the rate decision, the Fed will update its guidance for the rest of the year. If the meeting’s result is as expected, the economic forecasts could potentially be the big market mover. The Fed will provide its outlook for the economy, which serves as the basis for its rate decisions. On top of that is an update to the so-called “dot plot matrix”, a summary of where FOMC members think rates will be in the coming months and years.
How Many More Cuts?
The last time the dot-plot was published in June, it showed expectations for two rate cuts in the second half of the year. Markets generally interpreted that as a cut in September and a second in December. The pause in October would give the Fed time to better evaluate the situation. But there are only three meetings left this year. Which means that if the Fed cuts three times (or 75bps), then it would have to cut at every meeting going forward, including in October.
Therefore, the focus for the markets will be on what the Fed hints at for October. Some major banks, such as Morgan Stanley and Deutsche Bank, are expecting three rate cuts. The market is pricing in over an 80% chance, as well. So, if the dot-plot matrix says two more cuts after September, then the market will likely move to price in that October cut entirely. That is perhaps the more likely “dovish” scenario.
The Hawkish Surprise
Ever since Powell’s speech in Jackson Hole, markets have been pricing in a Fed dovish pivot. Odds of easing just kept rising after each bit of bad economic news. This leaves the markets in a potentially extended position, and the Fed might not deliver as much easing as has been hoped for. For example, simply creating ambiguity about an October cut might be enough for the markets to pull back. That would potentially leave the dollar stronger, gold weaker, and indices falling, and a surge in safe-haven demand.
For example, last week saw unemployment claims reported at a 4-year high. The odds of a 50 bps cut on Wednesday jumped. But it soon came out that the unusually high unemployment numbers were the result of attempts at identity fraud in Texas, and therefore, the real number would be revised lower. The disappointment in the markets afterwards suggests the degree to which traders are anticipating dovishness from the Fed, and illustrates the risk of a hawkish “surprise”.
What to Look Out For
Aside from the dot plot matrix, two other things could change the market’s outlook for rate cuts this year. The first is the economic projections, which will be updated at the same time as the interest rate decision is announced. If the Fed cuts its inflation forecast this year, that could be seen as dovish. The last Fed forecast was for PCE to end the year at 3.1%.
Then there is Fed Chair Powell’s customary post-rate decision press conference. He will likely try to walk a fine line between acknowledging the deteriorating labour conditions, but also not letting inflation expectations get out of hand. This could be tricky, and the market’s reaction could hinge on how he phrases his answers. But, unless he leaves the door wide open for a rate cut in October, then the market could interpret his views as hawkish.
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