The Fed will start a key shift this week - the first rate cut in over four years, as they are pursuing a rare move for the US economy.But after the bursting of the internet bubble and the Fed's rate cut in 2001, the ROI dropped by more than 10%..

With inflation seemingly under control, and signs of weakness in the US labor market, it is expected that the Fed will cut the benchmark lending rate by at least 25 basis points at the two-day meeting ending on Thursday Beijing time. In the financial markets, some traders, as well as economists from the largest US bank, JPMorgan, are even preparing for a larger 50 basis point rate cut.

This is a 'decisive moment' that will untangle the world's largest economy from a long period of rising borrowing costs. This move may be accompanied by signals from the Fed indicating its readiness to provide more 'relief' for US businesses and households in the coming months. This combination is expected to maintain the momentum of global asset revaluation, which has already begun.

"This is a huge bullish for Americans and the entire global economy," said Mark Zandi, chief economist at Moody's Analytics. "It will largely alleviate the pressure on the Fed's economy and allow it to move forward. This has been helpful as stock prices are higher than they would be without this situation."

However, decision-makers and the future path of the US economy are still full of uncertainties. Many investors and some economists are concerned that the Fed has waited too long, putting the labor market and economic growth on thin ice, injecting volatility into the financial markets. The latter was evident in the US Treasury market last Friday, when traders suddenly resumed betting on a 50 basis point rate cut.

The November presidential election has also put the Fed's decision in an unpleasant situation. Republican presidential candidate and former President Trump warned that the Fed should not cut rates before the election, while Democratic Senator Elizabeth Warren pressed officials to cut rates by 75 basis points.

"This is a key move," said Priya Misra, portfolio manager at JPMorgan Asset Management. "A soft landing is very rare."

JPMorgan is the only bank in the USA that insists on the Federal Reserve cutting interest rates by 50 basis points. However, although other banks have already returned to the expectation of a 25 basis point rate cut, the bank's Chief USA Economist Michael Feroli reiterated last Friday in a report to clients that a 50 basis point rate cut is the "right thing to do".

Misra also hoped that the Federal Reserve would cut rates by 50 basis points from the start, but she said that due to policymakers' concerns about the possibility of inflation continuing, a 25 basis point rate cut seemed slightly more likely. She added that if the Federal Reserve does indeed cut rates by 25 basis points, market reaction will largely depend on how officials "interpret" the smaller cut.

This is why, after the Federal Reserve cuts rates on Thursday, investors and analysts will focus on two things: the forecast of the Federal Reserve's benchmark interest rate path, the "dot plot", and half an hour later, the press conference to be held by Federal Reserve Chairman Powell.

These forecasts will provide each decision maker's expectations for the end of each year until 2027. This will include a glimpse of officials' expectations from now until the end of 2024, albeit anonymously. When policy is at a turning point, officials almost never provide such explicit disclosures, but the quarterly forecast schedule leaves them no choice.

"The year-end dot plot is now particularly important," said David Wilcox, former head of the Federal Reserve's Research and Statistics Division. "It will clearly get more attention as they are about to begin the rate-cutting cycle."

Specifically, the dot plot will show how many members of the Federal Open Market Committee (FOMC) are already inclined to further cut rates in November and December, and how many expect one of those cuts to be 50 basis points. If a significant number of officials support the latter, this means that the FOMC is not far from turning to more aggressive action.

Regardless of the number, it will show a significant change from the June forecast, where no decision maker expected more than two rate cuts this year.

Traders are more aggressive in their outlook for future rate paths. Since the disappointing non-farm payrolls report in July, they have been betting that the Federal Reserve will cut rates by about one percentage point in 2024. As of last Friday, they expected the Federal Reserve to cut rates by about 114 basis points by the end of December - including this week's rate cut. By the end of 2025, they expect the benchmark rate to fall to 3%.

Then there was a face-to-face meeting between Powell and reporters.

If the FOMC starts with a cautious 25 basis point rate cut, those who believe that the labor market is becoming risky would hope that the Fed chair sends a signal indicating that officials will be prepared to take more decisive action if necessary. Wilcox also suggests that Powell himself may want to keep his options open for future meetings, regardless of how much they cut rates at the outset.

"Any announcement - a 25-basis-point or 50-basis-point rate cut - could be described as a tough decision," says Wilcox, who has advised three Fed chairs. "To some extent, this could be seen as a compromise solution.

The number of soft landings has been few and far between.

Powell has indicated that he is prepared to act if the unemployment rate rises. In a speech delivered at the Jackson Hole central bank symposium on August 23, he stated that the Fed would "not seek or welcome a further intensification of labor market conditions."

His colleague and Fed governor, Waller, was even more direct on September 6. He not only stated that now is the time for rate cuts, but also explicitly stated that further deterioration in the labor market would provide the FOMC with the rationale for "prompt and vigorous action."

The consequences of falling behind could be severe. According to former Fed Vice Chairman Blinder, the Fed only achieved a clear soft landing in the mid-1990s, and the more common outcome is an economic recession. Setting aside the crash in 2020, the six recessions in the past 50 years have pushed the average unemployment rate up to 8.6%. A similar scenario would result in millions of people becoming unemployed.

The current unemployment rate is 4.2%, significantly higher than the historic lows experienced for most of the past three years. As early as April 2023, the unemployment rate was still at 3.4%, but it has been rising since then and triggered the Sam rule this summer, which typically indicates an economic downturn.

PineBridge Investments global multi-asset manager Michael Kelly did not predict a recession in the US economy, but he is concerned enough that he is buying long-term US Treasury bonds as a hedge against this outcome.

"What we have seen in the past is that once the labor market collapses, it collapses quickly," Kelly said. "Once the stones start rolling down the hill, it is difficult to stand in front of them and stop them."

However, Powell and his colleagues are excitingly close to achieving a goal that most economists thought would be nearly impossible after the price controls in the middle of 2021 disrupted global supply chains. Currently, inflation measured by indicators favored by the Fed has fallen to 2.5% in the year ending in July, and the unemployment rate remains low.

When the Fed began its mild 25 basis point rate hike cycle in March 2022 and took belated action on inflation, few economists predicted that the Fed would proceed unscathed to this point. Subsequently, officials accelerated the pace of rate hikes at subsequent meetings, eventually raising the target range for the benchmark rate to 5.25% to 5.5%, where it stands today. They have taken six significant rate hikes - 50 or 75 basis points each time.

Anything other than a 25 basis point rate cut at the Fed meeting would surprise the market, but the rate market could glean clues from changes in the median dot plot of the economic projections summary for 2025. If the Fed's rate outlook changes, short-term rate markets could react quickly after the rate cut announcement, but the highest probability is still that Powell will emphasize continuing to "rely on the data" in the press conference after the meeting.

During this process, the US economy has shown surprising resilience. Even after the Fed began raising interest rates, the unemployment rate continued to decline. Job vacancy rates, which surged during the pandemic, remain high, and prices stubbornly continue to rise, reaching their highest levels in 40 years in the summer of 2022.

However, recently the economy has slowed down. While layoffs remain rare, hiring has stalled, making it harder for job seekers to find work. The job vacancy rate has fallen to its lowest level since 2021. Meanwhile, higher mortgage rates and soaring housing prices have squeezed affordability, causing annual home sales in 2023 to drop to the lowest level in nearly 30 years.

Fed Chair Powell and other policymakers remain convinced that the labor market and overall economic conditions are still similar to their pre-pandemic health. Many members of the committee believe that the risks in the labor market are now roughly equal to the risks posed by inflation.

But the FOMC is not currently united internally. Some, such as Governor Waller and Chicago Fed President Gülsüm, are concerned that the threat to employment is now paramount. Others, such as Atlanta Fed President Bostic and Governor Bowman, still worry about resurgent inflation.

This means that anything on Thursday— from the committee's statement to the forecasts, down to every word Powell says— will be closely watched. Investors will be seeking reassurance that officials are still on a path to cut, to prevent a labor market meltdown, while also tackling inflation. Seth Carpenter, chief global economist at Morgan Stanley, said:

"This will require the Fed to strike a balance between its two mandates more than ever, and for markets, they will scrutinize these kinds of things carefully."

Editor/Lambor