Wall Street generally expects that if tonight's US retail data does not rebound like crazy, the Fed will start a rate cut cycle at its meeting later this week. However, as Nick Timiraos of the new 'Fed Communication Agency' said last Thursday, no one knows exactly how aggressive Powell and others will be.

As of the time of publication, the CME FedWatch tool showed a 67% chance of a 50 basis point rate cut in September, higher than 49% on Friday and only 15% the day before.

In the eyes of many Wall Street banks, a 50 basis point rate cut seems a bit rash. Bank of America has previously warned that a 50 basis point rate cut is "unreasonable, difficult to communicate, and could trigger a safe-haven shock." In contrast, the hawks represented by Nomura Securities and JPMorgan believe that a 50 basis point rate cut is a must.

Jack Hammond, head of US bond sales at Nomura Securities, pointed out in a recent report that the actual unemployment rate in the United States may be higher than the Fed's forecast, and core PCE inflation may be lower than expected. Important members of the FOMC such as Williams have indicated their agreement to a substantial rate cut. Nomura analyst Charlie McElligott pointed out that the Fed had previously raised interest rates by 75 basis points several times, so it is not surprising to start a rate cut cycle with a 50 basis point cut, and it may not necessarily cause market panic.

After studying the history of rate cut cycles, Nomura Securities found that three months after the Fed's 50 basis point rate cut, there was essentially no change, but small-cap stocks rallied, technology stocks performed well, value stocks outperformed growth stocks again, the US dollar rose, metal prices soared, and the yield curve steepened toward a bull market trend. $S&P 500 Index (.SPX.US)$There is basically no change, but small cap stocks surged, technology stocks performed well, value stocks once again outperformed growth stocks, the US dollar rose, metal prices soared, and the yield curve showed a steepening trend in the bull market.

JPMorgan predicts that the FOMC will cut interest rates by 50 basis points at the September and November meetings, followed by 25 basis points at each subsequent meeting. They also pointed out that the start of a Fed easing cycle often coincides with underperformance of risk assets.

Historically, after a 50 basis point rate cut, small cap stocks have soared and value stocks have outperformed growth stocks once again.

As history has shown, whenever the Fed has started an easing cycle with a 50 basis point rate cut, the market performance has been quite poor: January 2001 (after the dot-com bubble), November 2002 (slowing economic recovery), September 2007 (global financial crisis), and March 2020 (COVID-19 pandemic). But those are all in the past, as McElligott wrote in his latest report.

When people say, 'Well, a 50 basis point cut is telling the market that the Fed sees a big problem with the economy that could trigger a flight to safety,' my thought is that nothing is normal in this peculiar cycle (unprecedented monetary and fiscal interventions, market overreactions and underreactions, accompanied by sharp turns and institutional changes, resulting in momentum shocks).

In fact, in the span of a year and a half, we have experienced 11 Fed interest rate hikes, including several large hikes of 75 basis points... So, it should be expected to see corresponding measures during policy reversals, right?

Nomura studied all previous cases of a 50 basis point rate cut and analyzed market returns one month before and several months after the rate cut. Here are their findings:

In the 30 days before the interest rate decision, the S&P 500 index on average declined by 1%, with consumer staples being one of the best-performing sectors, rising by an average of 0.8%, while technology stocks were one of the worst-performing sectors, declining by 2.6%.

Small cap stocks.$Russell 2000 Index (.RUT.US)$It fell by an average of 1.7%, and the performance of energy stocks, industrial stocks, and precious metals was also poor. Value stocks outperformed growth stocks, and the yield curve showed a bull market trend.

Three months after the 50 basis point rate cut, the S&P 500 index remained basically unchanged (except in 2007, 2001, and 1974, when the S&P 500 index suffered heavy losses). On the other hand, small cap stocks rose an average of 5.6%. Technology stocks performed well, value stocks once again outperformed growth stocks, the US dollar rose, metal prices soared, and the yield curve became steeper in the bull market.

However, in the current unconventional economic cycle, Nomura's predictions may not be accurate. After all, during the recession in the United States following the outbreak of the pandemic, household net wealth grew for the first time, the returns of the S&P 500 index remained stable, profit margins were growing, and the job market was relatively tight.

Today's USA is more similar to 1995.

For the reasons mentioned above and others, JPMorgan believes that investors may be "exploring unknown territory". They also believe that the most similar situation today may be the rate cut cycle that began in 1995, when the rate was cut by 25 basis points for the first time.

JPMorgan pointed out that the rate cut cycle in 1995 had two main backgrounds:

The actual GDP growth rate was 2.7%, CPI was 2.5%, and the unemployment rate was 5.7%. The non-farm payroll data only dipped below 0.1 million twice that year. If those two instances are excluded, the average monthly non-farm payroll data was 0.207 million, and including those two instances, it was 0.179 million.

The rapid growth of M3 money supply is mainly due to a large inflow of funds into the Money Market Fund (MMF), whose yields adjust slowly as the money market interest rates decline.

The U.S. stock market has responded positively to the interest rate cut, with the S&P 500 index performing well.

TS Lombard analyst Dario Perkins believes that the "soft landing" of the U.S. in 1995 is a good sign for the Federal Reserve today.

Perkins wrote in the report that the current economic and financial environment does not show any obvious imbalances, reducing the risk of serious problems occurring when the Federal Reserve falls behind the market curve. The Federal Reserve may take larger interest rate cuts to avoid falling behind the market curve. If the Federal Reserve cuts rates by a smaller 25 basis points, it may cause market volatility in the September stock market slowdown.

Editor/Rocky