Tonight, the Federal Reserve will cut interest rates for the first time in five years, and the suspense surrounding the rate cut continues to increase. The debate on whether it will be a 50 or 25 basis point cut on Wall Street is ongoing, and market uncertainty has suddenly escalated. How will this "rate cut journey" by the Federal Reserve begin?

At 02:00 on Thursday, September 19th, the Federal Reserve will announce its interest rate decision for September, followed by a speech by Federal Reserve Chairman Powell at 2:30. Currently, a rate cut by the Federal Reserve is almost a certainty, but the magnitude of the rate cut remains uncertain.

Recently, whether it's inflation or non-farm payrolls, neither has provided a definite answer regarding the magnitude of the rate cut, leaving the market unsure whether it will be a 50 or 25 basis point cut. Moreover, during a period of silence by Federal Reserve officials, media reports suggesting a 50 basis point cut have shifted market expectations in that direction. Currently, the market is heavily betting on a 50 basis point cut, with a probability of 60%, whereas the probability for a 25 basis point cut is only 30%.

Currently, Wall Street is divided, with concerns about the labor market and the Federal Reserve being "behind the curve." One side is calling for a 50 basis point cut while the other is expressing concerns about ongoing inflation and the need to preserve options for future cuts, advocating for a 25 basis point cut.

However, whether it's 25 or 50 basis points, the market is likely to experience significant turbulence. The market is currently heavily betting on a 50 basis point cut, so if the Federal Reserve cuts by only 25 basis points, the market will face substantial losses. On the other hand, if the Federal Reserve cuts by 50 basis points but subsequently falls behind market expectations in its actions, it could trigger panic and tighten financial conditions once again.

In addition to the magnitude of the rate cut by the Federal Reserve, it is also worth paying attention to the "dot plot" and economic forecasts from the Federal Reserve, which are particularly important for rate cut predictions this year. Furthermore, Chairman Powell's remarks during the press conference are of significance.

The most controversial FOMC meeting: a 25 basis point cut means "huge losses", while a 50 basis point cut may cause "panic".

The Fed's decision has always been a focus of attention, but the meeting content is usually more predictable, while this time the controversy over the rate cut magnitude has reached its peak.

The recently released data has been a mixed bag, whether it's inflation or employment data, none have decisively determined the rate cut magnitude. Last Wednesday's CPI data showed that inflation remains sticky, increasing the probability of a 25 basis point rate cut, while last Thursday's PPI data cooled down year-on-year, slightly raising the possibility of a 50 basis point rate cut.

Until late last week, the expectation of a 25 basis point rate cut was prevailing, but market sentiment suddenly shifted on Friday, bringing the possibility of a 50 basis point rate cut to the forefront. Market sentiment was mainly influenced by reports from "The Wall Street Journal" and "Financial Times" last Friday, and Federal Reserve officials did not explicitly refute this in subsequent market movements.

Principal strategist Seema Shah said:

For the Fed, the ultimate decision is which risk is greater, whether a 50 basis point rate cut will rekindle inflationary pressures, or a 25 basis point rate cut will threaten economic recession. The Fed has been criticized for reacting too slowly to the inflation crisis, so it may cautiously address the risk of economic recession, avoiding a passive response rather than an active one.

However, whether it's 25 or 50 basis points, the market is likely to experience severe turbulence. The market is heavily betting on 50 basis points now, so if the Fed cuts by 25 basis points, it will be seen as "hawkish" and trigger risk shocks in the market.

Analysts point out that they are now locked in a record bet to align with the Fed's consensus on a 50 basis point rate cut. If officials opt for the standard rate cut, the market will face astonishing losses. 92% of economists expect this scenario to occur, and if the Fed unexpectedly takes action, federal funds will be forced to be drastically repriced, and all asset classes will suffer losses.

Since last weekend, trading volumes for October federal funds futures have soared to the highest levels since 1988, and more worryingly, data shows that most of these new bets are targeting a 50 basis point rate cut, with holdings surging just this week.

However, if a 50 basis point cut is chosen, such a sharp easing cycle would mean the economy is in trouble, but economic forecasts and company profit expectations remain quite optimistic. Analysts believe that this seems to be a completely contradictory information, both expecting a significant rate cut in the United States and expecting profits to continue to grow strongly. Historically, rate cuts have typically led to a 20% or more decline in reported profits, so expected profits are expected to decline by more than 30%.

In addition, in the absence of a significant improvement in economic conditions, future rate cuts may also be slower than market expectations. If the Federal Reserve is seen by the market as slowing its actions, the Financial Conditions Index (FCI) could tighten again, leading to lower oil prices, downward inflation expectations, and potentially upward pressure on real interest rates, pushing the US dollar higher.

The dot plot is especially important for interest rate forecasts this year.

Equally important as the rate cut is the "dot plot". Given that the Federal Reserve will disclose its latest dot plot for the interest rate trajectory in 2025 at this meeting, the market will seek clearer guidance from the Federal Reserve on the future pace and scope of rate cuts, which will also to some extent influence the market performance in September.

David Wilcox, who formerly led the Federal Reserve's Research and Statistics Division and is currently the Director of Economic Research at the Bloomberg Economics Research Institute, said:

The dot plot at the end of the year is now particularly important, as it is clearly receiving more attention because the Federal Reserve is on the cusp of beginning an easing 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.

The release of the dot plot will directly affect the market's pricing of interest rates. Since the disappointing July employment report released in early August, traders have been betting on a 100 basis point rate cut by the end of this year.

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

If the 'dot plot' released this time shows that the median policy rate forecast returns to or even lower than the level of March, it would mean that the monetary policy stance of the Federal Reserve is more dovish.

In addition, the Federal Reserve will also release related forecasts for unemployment rate, GDP, and inflation data.

According to analysts, the largest adjustment in September is likely to be related to the unemployment rate. The Federal Reserve is almost certain to raise the unemployment rate from 4.0% in June, while the current unemployment rate is 4.2%. Inflation expectations may be lowered, with core inflation projected to be 2.8% for the full year in June and 2.6% in July.

Goldman Sachs stated in a report that inflation seems to be lower than the FOMC's forecast in June, and the rise in inflation at the beginning of the year appears to be more like seasonal factors rather than acceleration. Therefore, a key theme of this meeting will be shifting the focus to labor market risks.

What will Powell say?

In addition to adjusting the dot plot and economic forecasts, the post-meeting statement of the FOMC will also be revised to reflect the expected rate cuts and other forward guidance of the committee.

Goldman Sachs expects that the FOMC may modify its statement, similar to:

I have more confidence in inflation and describe the risks of inflation and employment as more balanced, and once again emphasize their commitment to maintaining full employment.

Jefferies economist Thomas Simons believes:

I don't think they will give any specific forward guidance, which is almost useless at this stage of the cycle when the Fed doesn't really know what they want to do.

Editor/Lambor