The Federal Reserve, after experiencing the most severe inflation since the 1970s, has relaxed its monetary policy for the first time. This was supposed to be welcomed, but economists say that this highly anticipated move this week has been overshadowed by confusion and market volatility.

Derek Holt, Deputy Chief Economist at Bank of Nova Scotia, said in a report to clients, 'This should be a moment to celebrate, to some extent it is. Unfortunately, the communication between the Federal Reserve and the market has been quite poor, leading to increased volatility in market expectations regarding the size and pace of interest rate cuts.'

Last week, the probability of a 50 basis point interest rate cut at the September meeting of the Federal Reserve soared from less than 20% in the middle of the week to nearly 50% later on. The initial reason was that media reports quoted former Federal Reserve officials as saying they supported a larger rate cut.

Lou Crandall, Chief Economist at Wrightson ICAP, said, 'The Federal Reserve has spared no effort in putting the 50 basis point interest rate cut option back on the table.'

Mark Chandler, Chief Market Strategist at Bannockburn Global Forex, pointed out that such an evenly matched bet rarely occurs before a Federal Reserve meeting.

Scott Anderson, Chief U.S. Economist at BMO Capital Markets, said, 'The market has been actively preparing for dovish information from Federal Reserve Chairman Powell and the Federal Open Market Committee (FOMC) this week. In my opinion, this increases the risk of a hawkish surprise, which could at least temporarily disrupt the market.'

Many Wall Street economists insist on their calls for a modest 25 basis point interest rate cut at this week's meeting of the Federal Reserve, but in reality they all acknowledge that this is a critical moment. Some investment banks have expanded their expectations for rate cuts to 50 basis points. Some say that weak retail sales in August on Tuesday could push the Federal Reserve towards a 50 basis point rate cut.

Why is there so much confusion in the market?

Former global chief economist at bank of america securities, Ethan Harris, stated that economists are facing the challenge that the Federal Reserve's response to the economy has become increasingly unpredictable.

Harris said that most economists believe the Federal Reserve hopes to take gradual action, but in the recent interest rate hike cycle, the Fed abandoned this approach. Instead, it did not raise rates at the first sign of inflation, but later hiked rates significantly.

Prior to the COVID-19 pandemic, gradualism was a key part of the Fed's script. Harris told MarketWatch via email that this is because the outlook is always uncertain, and the Fed has been trying to avoid being fickle.

Why doesn't the Federal Reserve clarify its intentions?

Holt of bank of nova scotia suggests that Fed officials may not know what to do and hope to discuss the issue in meetings. 'It's quite normal,' he says.

'On the other hand, there may also be significant disagreements among policymakers to the extent that there is no clear support to reflect a united position. Or, it may be that the Fed believes there is no need to intervene when the market is falling,' added Holt.

Reasons for a 50 basis point rate cut

Lou Crandall, chief economist at Wrightson ICAP, said there are long-term concerns that a 50 basis point rate cut by the Federal Reserve may backfire and exacerbate worries about the Fed's impending economic challenges. However, investors last week seemed to view this as a more market-friendly Fed.

He added that recent surveys have shown that companies are eager for interest rate cuts.

Brian Bethune, an economist and professor at Boston College, said that American manufacturers are starting to be 'defeated' by the strength of the US dollar.

The reasons to lower interest rates by 25 basis points.

Holt said there is no urgent need to expand the scale of interest rate cuts. Financial markets are operating well and the US economy is resilient.

He said that the Federal Reserve is more likely to manage the market through smaller interest rate cuts. 'Lowering interest rates by 50 basis points now could bring a 'gotcha moment' to the market and be seen as a precedent. They may price future major moves, which could cause the Fed to adjust interest rates at a faster pace than it desires.'

Antonio Gabriel, Chief Global Economist at Bank of America Securities, said he will stick to his view of lowering interest rates by 25 basis points. 'The main message conveyed by the meeting should be to maintain a cautious and optimistic attitude despite downside risks,' he said.

Editor/new