In the past, even though the market would constantly speculate about the Fed's interest rate meetings, it was usually something that could be predicted. Policymakers would communicate their intentions in advance, the market would respond, and every investor would have at least a rough idea of what was about to happen.

But this time seems to be different.

This week's Federal Open Market Committee (FOMC) meeting was filled with an unusually mysterious atmosphere. Despite the collective belief in the market that the Federal Reserve will cut interest rates, there is still intense debate about the extent to which policymakers will lower rates.

Will the Fed take the traditional approach and cut rates by 25 basis points, or will they take a more aggressive first step and cut rates by 50 basis points?

Fed watchers are uncertain about this, which could make this FOMC meeting more influential than previous ones. The Fed's interest rate decision will be announced at 2 a.m. Beijing time on Thursday.

"I hope they cut rates by 50 basis points, but I doubt they will. I hope it's 50 because I think rates are too high," said Mark Zandi, chief economist at Moody's Analytics. "They have achieved their mission of full employment and inflation returning to target, which is inconsistent with a target federal funds rate of around 5.5%. Therefore, I think they need to normalize rates quickly and there is plenty of room to do so."

The pricing in the derivatives market has been unstable surrounding the actions that the Federal Reserve will take.

Until late last week, traders had been focused on a 25 basis point rate cut. But on Friday, market sentiment suddenly changed, bringing the possibility of a 50 basis point rate cut back into the discussion. As of writing, the market expects a 35% chance of a 25 basis point rate cut and a 65% chance of a 50 basis point rate cut at this week's meeting of the Federal Reserve.

Many Wall Street insiders continue to predict that the Federal Reserve's first move will be more cautious.

"Despite the apparent success of tightening policies, the effects have not fully matched their expectations, so loose policies should also be seen as equally uncertain," said Tom Simons, an economist at Jefferies. "Therefore, if you're uncertain, you shouldn't rush."

Moody's Analytics' Zandi expresses a more dovish view: "They should act promptly, otherwise they are likely to make mistakes."

Divergence is also expected within the FOMC.

Former Dallas Fed President Kaplan stated on Tuesday, "I suspect there are differences of opinion. Some people in the room will feel the same way I do, that their actions are a bit late and they want to step on the gas and not spend the fall chasing the economy. From a risk management perspective, there are also some who just want to be more cautious."

Other points of focus

In the eyes of analysts, apart from the debate over 25 or 50 basis points, this meeting is also expected to have other information worth paying attention to.

Exercise caution.

Since the last rate hike in July 2023, the FOMC has kept the benchmark federal funds rate between 5.25% and 5.5%.

This is the highest level in 23 years. Despite the Fed's preferred inflation indicator dropping from 3.3% to 2.5% during this period, and the unemployment rate rising from 3.5% to 4.2%, the interest rate has remained at this level.

In recent weeks, Fed Chairman Powell and other policymakers have made it clear that this meeting will result in a rate cut. To decide the extent of the rate hike, a balance needs to be struck between combating inflation and addressing the significant slowdown in the labor market over the past few months.

Seema Shah, Chief Global Strategist at Principal Asset Management, said, "For the Fed, the key is to determine which risk is greater - a 50 basis point rate cut would reignite inflationary pressures, while a 25 basis point cut might trigger a recession. Criticized for reacting too slowly to the inflation crisis, the Fed may take a passive response to the risk of an economic downturn, rather than a proactive approach."

The dot plot.

Perhaps as important as the interest rate cut is the signal that participants will send about their expectations for future interest rate trends.

This will be achieved through a "dot plot," where each official will indicate their views on the future direction of interest rates in a grid. This week's SEP will include forecasts for 2024 to 2027.

In June of this year, FOMC members only expected one interest rate cut before the end of the year. This is likely to accelerate, as with only three meetings left, market pricing has already reflected up to five 25-basis-point interest rate cuts, or a 125-basis-point reduction.

According to CME's Fed watch tool, traders expect the Fed to significantly lower interest rates next year, cutting the current overnight lending rate by 250 basis points before stopping the rate cuts.

Zandi, when discussing the market outlook, said, "This feels too aggressive, unless you know the economy is about to weaken significantly." Moody's expects the remaining three meetings of this year (including this week's meeting) to each cut interest rates by 25 basis points.

Economic Forecast

The dot plot is part of the FOMC Summary of Economic Projections (SEP), which also provides unofficial forecasts for unemployment, Gross Domestic Product (GDP), and inflation.

The unemployment rate is likely to be the largest adjustment made to the SEP, with the committee almost certainly raising the unemployment rate from the 4.0% forecasted in June. The current unemployment rate is 4.2%.

The core inflation rate forecasted in the SEP in June for the entire year was 2.8%, and this number may also be revised downward as the core inflation rate in July was 2.6%.

Goldman Sachs economists stated in a report, 'Inflation appears to be lower than the forecast given by the FOMC in June, and the high inflation earlier this year is increasingly looking like a residual seasonal effect rather than a reacceleration. Therefore, a key theme of the meeting will be shifting focus to labor market risks.'

FOMC Statement

In addition to adjustments to the dot plot and SEP, changes must also be made to the committee's post-meeting statement to reflect the expected rate cut and any additional forward guidance the committee will provide.

The statement and SEP, released at 2:00 am Beijing time on Thursday, will be the first things the market will react to, followed by the press conference held by Powell at 2:30.

The wording of the statement may undergo several changes, including language on the balance of risks between employment and inflation.

The July statement stated that these risks "continue to trend towards a better balance." Julia Coronado and Laura Rosner-Warburton of MacroPolicy Perspectives stated that this statement is now inconsistent with recent remarks by Powell and Fed Director Waller. Coronado and Rosner-Warburton suggest that the FOMC could adopt a similar statement to Waller's remarks on September 6: "The balance of risks has turned towards the employment aspect of our dual mandate."

Goldman Sachs expects that the FOMC "may modify its statement to signal more confidence in inflation and describe the risks to inflation and employment as more balanced, and reiterate its commitment to maximizing employment."

The committee may also choose to describe further weakness in the labor market as "unwelcome," a term used during the Greenspan era that Powell has used again in a recent speech.

Economists have different views on whether and how policymakers will signal future interest rate cuts in the statement. About 44% of economists surveyed said officials will acknowledge the possibility of further adjustments in the document, while 31% said they will provide more explicit guidance on seeking a series of rate cuts and offer guidance on the pace of rate cuts.

Jefferies economist Simons said, "I don't think they're going to be particularly specific about any form of forward guidance. Forward guidance at this stage of the economic cycle doesn't have much utility because the Fed doesn't really know what it wants to do."

Powell Press Conference

The subsequent press conference will not only provide insight into the committee's thinking, but also shed light on Powell's views. Fed watchers believe that Powell is more concerned about the recent softening of the labor market than the general view of the committee.

Powell is increasingly convinced that the Fed can contain inflation without impacting the economy and employment. A spike in unemployment now would bring high political and economic costs, which is a situation that any central bank governor wants to avoid.

Anna Wong, Chief Economist at Bloomberg Economics, said, 'The Federal Reserve is almost certain to start an interest rate cut cycle at the meeting on September 17th - 18th. Whether they start with a 25 basis point cut or a 50 basis point cut is still unknown. In our view, consistency in forecasts and risk management suggest that a 50 basis point cut is the right choice. So far, there has been a lack of clear guidance on the possibility of a significant rate cut, indicating a preference for a 25 basis point cut.'

If officials do choose to cut rates by 25 basis points, Powell will be free to indicate that his goal is to prevent further deterioration in the job market.

'The message conveyed will be: we want to have more ammunition but we won't use it today,' said Ellen Meade, former Senior Advisor for Policy and Communication at the Federal Reserve and current Research Professor at Duke University.

Editor / jayden