As September 18, 2024, unfolds, all eyes are on the US Federal Reserve as it concludes a pivotal meeting expected to result in the first rate cut in over four years. This decision could mark a significant shift in the Fed’s monetary policy amidst growing concerns over the state of the global economy, including recession fears and inflationary pressures. With US retail sales showing resilience and economic signals remaining mixed, the size and impact of the Fed rate cut will be keenly observed by financial markets worldwide.
The burning question on everyone’s mind: will Fed Chair Jerome Powell announce a 25-basis-point (bps) or 50-bps cut? Investors are closely monitoring every update, as this could set the tone for both the US and global financial outlooks.
How the Markets Are Reacting
US Stock Indices Await Fed’s Decision
On Wednesday morning, Wall Street appeared to stall as investors awaited the Fed’s announcement. Major indices, such as the S&P 500 and Dow Jones Industrial Average, hovered near record highs, while trading volumes remained relatively muted. The S&P 500 edged only slightly higher, sitting just below its all-time high from July, while the Nasdaq Composite was also flat, reflecting the market’s cautious anticipation of the Fed’s rate cut decision.
While some experts argue that the market may not experience significant changes regardless of whether the Fed cuts by 25 or 50 basis points, there is a consensus that anything less than a 50-bps cut could result in disappointment. BTIG analysts expressed concern that a false breakout might occur, leading to volatility in equity markets if the Federal Reserve does not meet or exceed market expectations.
Investors Eye Global Impact
Beyond the US, European markets also experienced slight declines as investors digested local inflation data while preparing for the Fed’s announcement. The pan-European Stoxx 600 index fell by 0.45%, with major sectors such as healthcare and media showing weakness. Similarly, oil prices dropped ahead of the Fed’s decision, as analysts suggested that recent price rallies may have already factored in the anticipated rate cut.
In the UK, inflation remained steady at 2.2% in August, and the market is now looking ahead to the Bank of England’s upcoming policy meeting. Across the globe, central banks are expected to follow the Fed’s lead, adjusting their policies based on the US decision, with some analysts predicting coordinated rate cuts aimed at sustaining economic growth.
Retail Sales: A Surprising Bright Spot
Amidst concerns about a potential economic slowdown, the US retail sales report for August provided some relief. Contrary to economists’ expectations of a 0.2% decline, retail sales increased by 0.1%, suggesting strong consumer spending despite recession fears. Excluding auto sales, retail sales also rose by 0.1%, slightly missing the forecast of a 0.2% increase.
While these figures may not be a significant upside surprise, they indicate that US consumers are still willing to spend, which may support the economy in the coming months. However, with the labor market showing signs of softening, this trend may not last if wages and employment data weaken further.
The Key Debate: 25 or 50 Basis Points?
CME FedWatch: Market Sentiment Shifts Toward 50 Basis Points
The size of the Fed’s rate cut has been the subject of intense speculation. According to CME Group’s FedWatch tool, market sentiment has shifted in favor of a 50-bps rate cut, with the probability of such a cut increasing to 67% from just 47% last Friday. This shift reflects growing confidence that the Fed may opt for a more aggressive stance to stave off recessionary pressures.
A 25-bps cut, while still possible, may not provide the kind of boost markets are hoping for. Analysts like Jonathan Krinsky of BTIG argue that a smaller cut could be underwhelming, given that the market is already pricing in a more significant reduction in interest rates by year-end. Moreover, former Fed Vice Chair Richard Clarida has suggested that a quarter-point cut would be a prudent approach, focusing on future economic conditions rather than reacting to immediate data.
Why a 50-Basis-Point Cut May Be Necessary
With inflation nearing the Fed’s 2% target and economic growth still relatively robust, a 50-bps cut may seem excessive to some. However, certain market experts, including Mark Matthews of Bank Julius Baer & Co., believe that a 50-bps cut is necessary to reassure investors and maintain market stability. Matthews noted that failing to meet market expectations with a smaller cut could lead to disappointment and increased volatility in equity markets.
Another factor contributing to the call for a larger cut is the broader economic landscape. US crude oil prices have declined sharply in the third quarter, down more than 13%, signaling concerns over a supply-demand imbalance. Meanwhile, global inflation trends, particularly in the eurozone, have shown improvement, but inflation remains above the European Central Bank’s target. These global dynamics underscore the need for a decisive action from the Federal Reserve to prevent a potential slowdown from escalating into a full-blown recession.
The Broader Economic Impact
Implications for Borrowing Costs
One of the most immediate effects of a rate cut will be on borrowing costs, both in the US and globally. A reduction in the Fed funds rate will likely lead to lower interest rates on loans, making it cheaper for businesses and consumers to borrow. This could be a boon for sectors such as housing and automotive, where credit plays a crucial role in sustaining demand.
For US consumers, lower interest rates on mortgages could further spur activity in the housing market. In fact, the 30-year fixed mortgage rate has already dropped to a two-year low of 6.15%, and home loan applications have surged as a result. This trend is expected to continue as the Fed rate cut takes effect, providing relief to homebuyers and those looking to refinance their loans.
However, the impact on savings accounts could be less favorable. As banks adjust their rates in response to the Fed’s decision, savers may see lower returns on deposits. This may prompt individuals to seek alternative investment options, such as stocks or bonds, to achieve better returns.
Global Spillover: Central Banks Poised to Follow
The Fed’s decision will also influence central banks worldwide, with several scheduled to announce their own monetary policies later this week. The Bank of England, the Bank of Japan, and other major institutions will likely take cues from the Fed’s move, especially if the cut is on the larger side.
In the eurozone, where inflation has dropped to a three-year low of 2.2%, the ECB may be compelled to follow suit with further rate cuts to keep inflation within its target range. Similarly, emerging markets such as India may also react to the Fed’s decision, particularly if the rate cut leads to a weakening of the US dollar, which could impact global trade and investment flows.
The Fed’s Long-Term Strategy
While the immediate focus is on the size of the rate cut, the Federal Reserve’s long-term strategy remains a topic of debate. Some analysts, such as Mohamed El-Erian, caution that the market’s expectations for deep cuts may be unrealistic given the current strength of the economy. El-Erian, former head of bond-focused asset manager PIMCO, argues that the Fed may opt for a more gradual easing cycle, leaving rates higher than what many expect.
Others, such as economist Steve Hanke, believe that the Fed has already delayed its response too long and that a recession is imminent regardless of today’s rate cut. Hanke points to the shrinking US money supply since July 2022 as a key indicator of an impending downturn, warning investors to avoid risk assets like stocks in favor of safer options such as gold and US Treasuries.
Conclusion
As the US Federal Reserve prepares to announce its first rate cut since March 2020, markets remain on edge, with investors and analysts divided over the size and impact of the cut. Whether the Fed opts for a 25 or 50-basis-point reduction, the decision will have far-reaching implications for global markets, borrowing costs, and the broader economy. While the immediate impact may be subtle, the long-term effects of this policy shift will be felt for months to come. Stay tuned as the Fed meeting concludes and the world reacts to this crucial moment in economic history.
