Source: Wall Street See
Author: Zhang Yaqi.

This week, the Federal Reserve is about to achieve its first interest rate cut in four years, and global investors will hold their breath in anticipation.

The market generally expects that the Federal Reserve's interest rate cut will be at least 25 basis points, while JPMorgan and some economists predict that the cut may reach 50 basis points.

This interest rate cut marks the beginning of the end of the Federal Reserve's years-long high interest rate policy, opening the door for the repricing of trillions of dollars in assets globally.

What to watch for in the most important meeting of the Federal Reserve in recent years?

In addition to the magnitude of the interest rate cut, the dot plot is particularly important for this year's interest rate cut forecast. If more members support a larger interest rate cut, the market may adjust asset pricing accordingly. In addition, how Powell "explains" the magnitude of the interest rate cut at the press conference will also affect the volatility of the financial market.

"Decisive moment" is coming!

This is a "decisive moment" that will free the world's largest economy from a long period of rising borrowing costs.

"This is a huge bullish for Americans and the global economy," said Moody's chief economist Mark Zandi, "It will greatly alleviate the pressure on the Fed's economy and allow it to move forward. This has already helped, with stock prices higher than they would be otherwise."

However, the path for decision makers and the future of the US economy remains uncertain. While rate cuts may bring about loose policies, many investors and some economists are concerned that the Fed has waited for too long, putting the labor market and economic growth on thin ice and injecting volatility into financial markets. Last Friday, the US bond market experienced significant volatility, reflecting increased market expectations of a 50 basis point rate cut.

In addition to considerations of economic fundamentals, the Fed also faces pressure from the political arena. As the November US elections approach, Republican candidate and former president Donald Trump warned that the Fed should not cut rates before the vote; meanwhile, Democratic Senator Elizabeth Warren has been pressuring officials to reduce rates by 75 basis points.

Moody's asset management company's portfolio manager, Priya Misra, believes that a 50 basis point rate cut is "the right thing to do".

However, she noted that due to policymakers' concerns about the persistence of inflation, a 25 basis point rate cut seems slightly more likely. She added that if the Fed indeed cuts rates by 25 basis points, market reaction will largely depend on how officials "interpret" the smaller cut.

That's why investors and analysts will focus on two things after the Fed's rate cut at 2:00 AM on Thursday: the forecast of the Fed's benchmark interest rate path, known as the "dot plot", and the press conference to be held by Fed Chairman Powell half an hour later.

The dot plot is particularly important for this year's interest rate forecast.

First of all, the dot plot for this meeting will be crucial because it reveals the Fed policymakers' expectations for interest rate trends until 2027.

This meeting marks the possibility of the Fed entering an interest rate cut cycle, and the dot plot will reflect policymakers' views on the number and magnitude of future rate cuts.

"The year-end dot plot has now become particularly important, as it is clearly more closely watched due to the Fed being on the edge of starting an interest rate cut cycle."

Specifically, the dot plot will show the divergence of opinions within the FOMC, such as how many members are in favor of further rate cuts in November and December, especially if a significant number of members are inclined to further cut rates by 50 basis points before the end of the year, which would indicate that the Fed may take more aggressive actions in the future.

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.

The release of the dot plot will directly impact the market's pricing of interest rates. Since the disappointing July employment report released in early August, traders have been betting on a full 100 basis points rate cut by the end of this year. As of last Friday, traders expected a rate cut of about 114 basis points by the end of December. By the end of 2025, they expect the benchmark interest rate to fall to 3%.

If the dot plot shows more members supporting larger rate cuts, the market may adjust asset pricing accordingly, pushing market expectations even lower.

The press conference by Powell focuses on the interpretation of interest rate decisions.

Fed Chairman Powell will deliver a speech at the press conference after the interest rate meeting. His remarks often provide more background and details, especially regarding the considerations behind the policies.

If he hints at further interest rate cuts or expresses concerns about economic risks in his speech, the market may adjust its investment strategy accordingly. In addition, how Powell 'explains' the magnitude of the rate cut (such as 25 basis points or 50 basis points) will also affect the volatility of the financial markets.

Wilcox, who has advised three Fed chairs, suggests that Powell himself may also want to leave room for future meetings, regardless of the initial amount of the rate cut.

"Whether the Fed announces a 25 basis point or 50 basis point rate cut, the final decision is very close." Wilcox said, "In a sense, this decision can be seen as a 'divided decision.'" He suggests that there may be different opinions within the Fed and that there is no absolute consensus.

"But after the bursting of the internet bubble and the Fed's rate cut in 2001, the ROI dropped by more than 10%."Facing numerous challenges."

Facing a weakening U.S. labor market, Fed Chairman Powell stated that if the unemployment rate continues to rise, the Fed will take interest rate cuts to address it.

However, historical experience has shown that achieving the so-called "assets management" is very difficult. The Federal Reserve has only successfully avoided economic recessions in the mid-1990s. In most cases, lowering interest rates too late will trigger an economic downturn.But after the bursting of the internet bubble and the Fed's rate cut in 2001, the ROI dropped by more than 10%.However, historical experience has shown that achieving the so-called "assets management" is very difficult. The Federal Reserve has only successfully avoided economic recessions in the mid-1990s. In most cases, lowering interest rates too late will trigger an economic downturn.

Currently, the unemployment rate in the USA has risen from 3.4% in April last year to 4.2%, indicating a slowdown in the job market. At the same time, rising mortgage rates and soaring house prices have led to a decrease in housing market activity to the lowest level in nearly 30 years.

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've seen before is that once the job market collapses, it collapses quickly," Kelly said. "Once the stones start rolling down the hill, it's hard to stand in front of them to stop them."

BI strategists Ira F. Jersey and Will Hoffman stated:

Any measures at the Federal Reserve meeting other than a 25 basis point rate cut would catch the market by surprise, but the rate market may glean clues from changes in the dot plot.

If the Fed's rate outlook changes, the short-term rate market may quickly adjust after the initial reaction. But the most likely scenario remains: Powell will emphasize continued "data dependence" at the post-meeting press conference.

There are also divisions within the Federal Reserve on how to balance the risks of inflation and the job market. Some officials such as Atlanta Fed President Raphael Bostic and Michelle Bowman are concerned about inflation rebounding, while others such as Christopher Waller and Austan Goolsbee are more focused on the deterioration of the job market.

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/rice