Source: Jin10 Data
Author: Wu Yu.

As the Federal Reserve is about to embark on its first rate cut in over four years, the market is uncertain about the magnitude of the rate cut. One of the culprits contributing to this situation is the well-known financial journalist Nick Timiraos, who is referred to as the "New Federal Reserve News Agency." At that time, he described a 25 basis point or 50 basis point rate cut as a "close decision." On Tuesday, he once again wrote that the scale of the Federal Reserve's first rate cut is questionable. The following is an excerpt from the full text.

The Federal Reserve will cut interest rates at the two-day meeting ending on Wednesday Eastern Time, with the goal of maintaining a stable job market when price pressures have cooled down.

The decision whether to cut the Federal Reserve's benchmark interest rate by 50 basis points or the traditional 25 basis points will depend on how Federal Reserve Chairman Powell leads his colleagues in a series of careful considerations.

Former Federal Reserve senior advisor William English said, "For them, the key question of this meeting is their perception of risk balance. If they are more concerned about growth and employment rather than inflation, they are likely to want to take some precautionary measures, namely cutting interest rates by 50 basis points. The rationale for a 25 basis point rate cut is based on different considerations, including a strong economic fundamentals or the risk of reigniting inflation from excessively rapid rate cuts."

English said a few weeks ago that he believed a smaller rate cut is appropriate. However, the recent downward trend in employment data has made him more anxious, especially since even after two to three rate cuts, the rates will still be at relatively high levels.

Federal Reserve officials typically prefer to raise or cut interest rates in increments of 25 basis points to study the impact of these measures. However, they act more quickly when they believe their rate stance is not well aligned with the risk balance. For example, in 2022, the Fed raised rates at a pace of 50 and 75 basis points to combat high inflation.

Change in rate cut expectations

Until late last week, investors expected the Fed to cut rates by only 25 basis points this week, as few officials openly called for a larger rate cut. "Their communication suggests a 25 basis point rate cut. And the data performance is also acceptable," said former Fed Governor Laurence Meyer.

Esther George, who served as President of the Kansas City Federal Reserve Bank from 2011 to 2023, said that due to inflation still above the Fed's target, and the overall good economic conditions, "you can start with a 25 basis point rate cut and then say, 'We will maintain this rate cut pace for a while, and if the situation looks weaker, we can increase the intensity.'"

Federal Reserve officials did not commit to a rate cut magnitude on the eve of the pre-meeting quiet period that began on September 7th. Fed board member Bullard said on September 6th, following the release of the latest employment report, "I advocated raising rates earlier when inflation accelerated in 2022, and if appropriate, I would also advocate for a cut in rates."

In the subsequent Q&A session, he seemed relatively calm about the recent slowdown in job growth. He said that even if monthly job growth falls to 0.1 million, "that's okay", "there's nothing to be afraid of."

New York Fed President Williams said in a speech on the same day that recent data shows "a fairly common trend... what we see is a persistent cooling signal. We hope the economy remains balanced."

Is a 50 basis point rate cut "regrettable"?

Federal Reserve officials often refer to their work as risk management, for example, ensuring that they balance the risks of inflation heating up with the risks of accelerated unemployment. They typically manage these risks by adjusting interest rates, which may appear to be more costly. For most of the past two and a half years, as the inflation rate soared to over 7%, risk management tended to adopt more aggressive rate hikes to prevent inflation from becoming entrenched.

Robert Kaplan, who served as the President of the Dallas Fed from 2015 to 2021, has stated that it would make sense to begin an easing cycle with a 50 basis point cut if officials were to consider which choice they are unlikely to regret at this week's meeting.

"If I were still in my original position, I would say, 'I could accept a 25 basis point cut, but I would support a 50-basis point cut,'" said Kaplan, the current Vice Chairman of Goldman Sachs. He believes that considering inflation and unemployment, the Fed's benchmark interest rate should be about 100 basis points lower than it is now.

Kaplan stated that because inflation has not yet been fully defeated, the Fed should avoid further economic weakening, which would force the Fed to cut interest rates faster or by a larger magnitude to prevent a recurrence of inflation.

He said that if the economic conditions between now and the next meeting in early November are poor, Fed officials are unlikely to regret a larger rate cut this week, as interest rates would still be at relatively high levels. However, if the Fed takes smaller action and the labor market deteriorates more quickly, officials will be more regretful.

The minutes of the late July Federal Reserve meeting showed that some officials at the time supported rate cuts, but most preferred to wait. Meanwhile, the July hiring data released after the Fed's July meeting fell far below expectations.

"The Fed has fallen behind by one meeting, and they have a chance to catch up. But if they could do it over again, I would have wanted a rate cut in July," Kaplan said. "I'd rather correct this now, be proactive, than be behind the curve all fall, chasing economic decline."

Which way is the road?

As important as the decision to cut interest rates by the Fed this week is the publication of its quarterly economic forecasts, which show officials' expectations for year-end interest rate levels. While not the result of committee deliberation, these forecasts are usually just as important to the financial markets, as the outlook for interest rates from policymakers could affect a range of borrowing costs for mortgages, auto loans, and corporate debts.

The updated forecasts at the September meeting can provide particularly valuable information, as the Fed only has two more meetings scheduled for November and December this year. The new forecasts will offer unusually specific guidance for these meetings' decisions.

If more officials anticipate a total rate cut of 100 basis points this year, it would mean there will be at least one cut of 50 basis points. Delaying a larger rate cut to later in the year could spark awkward questions about why it's the best approach. Another option is to cut rates by 25 basis points now and expect similar measures at the last two meetings of the year, while retaining the option to accelerate the pace of rate cuts in the event of further economic deterioration.

Given the evenly balanced decision this week, Powell may face opposition from at least one policymaker. The 12 policymakers include 7 members of the Federal Reserve Board and 5 regional Federal Reserve Bank Presidents, who vote on policy. Over the past two years, no Fed officials have voted against a policy decision, making it the longest streak in the past half century. In addition, no Fed Board members have dissented on interest rate decisions since 2005.

Ingelbrist cautioned that the Fed's interest rate decision this week is at a critical juncture, reflecting officials' uncertainty about the choice. "This isn't to say that you have half the committee members supporting a 50 basis point cut and half supporting a 25 basis point cut, yelling at each other. It’s that no one really knows what the right thing is to do here," he said. "In the end, Powell may have to build a reasonable consensus around one side."

Editor/rice