Goldman Sachs' expectation of a 50 basis point rate cut 'sings a different tune': the pricing is too aggressive, and the expectation may fall short.

On the eve of the Fed's decision, boosted by the views of mainstream financial media such as the 'Fed News Service', the probability of a 50 basis point rate cut in the forward market has surged well above 50%.

But Goldman Sachs' FICC trader Borislav Vladimirov issued a warning that there is a risk of expectation falling short in the market.

Vladimirov pointed out that based on the current asset performance, in September, gold, US long bonds, and yen outperformed other assets, while the Nikkei index, energy, and the Euro Stoxx 50 index suffered losses. This market performance usually accompanies a softening in the US and global economic growth. Under this circumstance, the market generally expects central banks to loosen monetary policy and engage in 'quantitative easing (QE) trades'.

In other words, the current market pricing is quite aggressive, and unless there is a new large-scale global recession or crisis prompting the Fed to adopt new QE policies, the market's expectation will certainly fall short, thereby negatively impacting market sentiment and asset prices.

Looking ahead, even if the Fed implements a larger 50 basis point rate cut, subsequent rate cuts may be slower than the market's expectation, given the absence of significant improvement in economic conditions.

If the interest rate is not lowered by 50 basis points, traders may face historic losses.

The trading volume of October federal funds futures, which are betting on the Federal Reserve's interest rate decision tonight, has reached a record high. This means that if the Federal Reserve fails to cut interest rates by a significant 50 basis points as expected by the market, the unprecedented scale of federal funds contracts will be forced to reprice significantly, and all asset classes will suffer losses.

In addition, a smaller rate cut is seen as a 'hawkish' signal or could trigger a wave of risk aversion.

In addition to the potential slowdown in future rate cuts by the Federal Reserve, financial conditions indices (FCIs) will tighten again, leading to lower oil prices, downward inflation expectations, and the possibility of upward pressure on real interest rates and boosting the US dollar.

Therefore, according to Goldman Sachs, the initial 50 basis point rate cut should not be seen as a green light for selling volatility or arbitrage, as there is a high risk of data or policy surprises in this macroeconomic situation.

However, Vladimirov also pointed out that there is not much short-term risk. If the Federal Reserve decides to cut interest rates by 50 basis points as scheduled on Wednesday, risk assets may see further rebound in the next 5-10 trading days, boosted by improved risk sentiment.

Investors are closely watching whether the 'dot plot' will be significantly lowered.

The report points out that considering the release of the Federal Reserve's latest 2025 interest rate projection 'dot plot' at this meeting, the market will seek clearer guidance from the Federal Reserve on the pace and scope of future rate cuts, which will also have some impact on market performance in September.

Some believe that if the Federal Reserve cuts interest rates by 50 basis points as expected by the market, it may trigger expectations for further rate cuts in the future. Therefore, if the 'dot plot' announced this time is not significantly lowered to meet market expectations, especially for the interest rate expectations at the end of 2025 (the difference between current market expectations and official expectations is 1.25%), the market may feel disappointed and it may trigger a wave of risk aversion.

In the 'dot plot' released by the Federal Reserve in June, the median forecast for the policy rate in 2025 was raised from 3.75% in March to 4.15%. The report states that if the 'dot plot' released this time shows that the median forecast for the policy rate returns to or is lower than the level in March, it would mean that the Federal Reserve's monetary policy stance is more dovish.

The key to the stock market trend lies in the economic situation, and the risk of a hard landing still exists.

Regarding the US stock market, some believe that since the stock market has fully digested the expected rate cut and is already at a historical high, the upward space is expected to be limited after the first rate cut by the Federal Reserve.

There are also opposing views. Andrew Tyler, head of market intelligence at JPMorgan, pointed out that in the past 12 months, the S&P has accumulated a 25% increase. Historically, in the 12 months prior to the first rate cut by the Federal Reserve, the average increase in the index was only 4%. It is expected that the US stock market will continue its good momentum.

Tyler stated that once interest rates truly begin to decline, the stock market performance will depend on the results of economic growth. Out of the past 12 easing cycles, 8 were accompanied by economic downturns, with 4 of them resulting in a soft landing.

Financial blog ZeroHedge believes that the risk of an economic hard landing still exists. Currently, the money market expects a rate cut of over 100 basis points within the year, with a further 100 basis points cut in 2025. Such a sharp cut in interest rates seems to indicate that the economy is already in trouble.

However, the expected profit growth rate for the S&P next year remains as high as 14%. Andrew Lapthorne of Natixis pointed out, 'A 'significant rate cut by the Federal Reserve' and 'sustained strong profit growth' are conflicting pieces of information:'

'Historical data shows that such a rate cut often leads to a profit decline of 20% or more, with an expected profit decrease of over 30%.'

This is also the logic of "selling the first interest rate cut" emphasized by Michael Hartnett, Chief Investment Strategist at Bank of America. He believes that the risk of a hard landing is underestimated, and in fact, the profitability level of small businesses in the United States is at its lowest level in fourteen years, and employment data is also showing a downward trend.

Editor/Lambor