Investors are facing a trillion-dollar question, that is, at the upcoming Federal Open Market Committee (FOMC) meeting this week, whether the Federal Reserve will cut the federal funds rate by 25 basis points or a full 50 basis points. This will be the first rate cut by the Federal Reserve in over four years.

The final result of this FOMC meeting will not be released until 2:00 AM Beijing time on Thursday, followed by Fed Chair Powell's press conference at 2:30.

In the past few years, the Federal Reserve has been trying to manage expectations and avoid shocking the market at FOMC meetings. However, this time, the market still seems unable to reach a consensus on whether the rate cut will be 50 basis points or 25 basis points this week.

There is a significant split in market expectations.

At last month's Jackson Hole Symposium, Powell set the tone for this FOMC meeting, announcing that with the decline in inflation risks, the "time for a rate cut has come".

According to data from the CME FedWatch tool, the call for a substantial rate cut is growing, with 60% of Wall Street traders predicting that the Federal Reserve will cut rates by 50 basis points. In addition, the options market expects the Federal Reserve to cut rates by at least 100 basis points this year.

Market veteran Nilesh Shah reminds investors that since mid-2023, the market's expectations for the Federal Reserve interest rate path have often been wrong.

He said, "People had expected the first interest rate cut to be in mid-2023, but I feel that this time the market will also be wrong in predicting the prospect of a Fed rate cut. Our feeling is that the actual rate cut by the Fed will be lower."

Respondents in the CNBC survey also predict that the Fed's current rate cut cycle will be more gradual than the current market pricing.

The survey shows that out of the 27 respondents, including economists, fund managers, and strategists, 84% believe that the Fed will cut rates by 25 basis points, while 16% believe it will be a 50 basis point cut.

The main reason for the discrepancy between respondents and market expectations is that the former seem to have less concern about the overall economy and are more confident that the Fed has time to gradually cut rates. 74% of respondents said that the rate cut in September came at just the right time, while only 15% said it was too late.

David Doyle, head of macroeconomics at Macquarie, said, "Although the Fed is likely to make larger rate cuts, our basic expectation is a 25 basis point cut at this meeting, with a total of 200 basis points cut by next year."

What would trigger a larger rate cut?

Macquarie's global forex and rate strategist Thierry Wizman and others said that the only reason for a 50 basis point rate cut would be if a financial crisis erupted a few days before the FOMC meeting, but now there are less than 24 hours left until the meeting ends, which seems unlikely.

Some experts warned that a 50 basis point rate cut could scare the market, and they may attribute a larger-than-expected rate cut to the Fed attempting to overcome imminent economic turmoil, but not everyone agrees that the Fed needs to hurry.

Claudia Sahm is a representative of famous economist.

Sahm is most famous for her creation of the recession indicator of the same name, which was triggered after the July nonfarm payroll data was released.

In a recent blog post, Sahm explained the reasons for a 50 basis point interest rate cut, emphasizing that "progress in inflation alone shows that the start of a Fed easing cycle is reasonable," and provided reasons for a 25 basis point interest rate cut. The reason for an additional 25 basis point cut is that the cooling rate of the labor market conditions is faster than expected.

"The labor market has not remained strong," Sahm wrote. "Disappointing labor market data since the July FOMC meeting should lead to an additional 25 basis point interest rate cut."

Neil Dutta of Renaissance Macro Research also refuted criticism that a 50 basis point interest rate cut would panic the market, saying that only a 25 basis point cut would lead to real risks. He wrote in a report to clients Monday morning:

"A 25 basis point rate cut actually amounts to tightening financial market conditions. Monetary policy operates through financial markets. When there is a change in the risk balance between growth and inflation as it is now, tightening the financial environment should be avoided. If the downside risks to employment outweigh the upside risks to inflation, then, under otherwise similar conditions, the Fed should lean against a tightening of the financial environment."

What is most important for the market?

Whether the Fed chooses a 25 basis point or 50 basis point interest rate cut, the most important factors influencing market trends will be Powell's announcement of the rate cut and the updated dot plot.

Shibani Sircar Kurian, the mutual fund manager of Kota, said, "If the Fed cuts interest rates because inflation has slowed, and the growth is slowing but not falling off a cliff, and this is a slow and steady rate cut cycle, then it will be beneficial for the stock market. However, if the rate cut cycle accelerates due to an economic recession, then it will be unfavorable for the stock market."

Kurian added that the Federal Reserve is walking a tightrope before the November US presidential election. On the one hand, they need to cut interest rates to support the economy, but they do not want inflation to come back.

David Kostin, the chief US stock strategist at Goldman Sachs, wrote that his team expects the S&P 500 index to reach 6000 points in the next 12 months, and the success of this target depends entirely on whether the Fed's actions can maintain the current soft landing narrative.

"Although some investors believe that the speed of the Fed's interest rate cuts will be the key determinant of stock market returns in the coming months, the growth trajectory is ultimately the most important driver of the stock market," Kostin wrote.

Editor/Lambor