Wall Street and the Federal Reserve have reached a consensus on the magnitude of the initial 50 basis points rate cut, however, there is still considerable disagreement between the two on the speed of the next rate cut.

Wall Street bets that the deterioration of the economy and labor market will force the Federal Reserve to accelerate the pace of rate cuts. The Federal Reserve, on the other hand, is inclined to continue reducing rates at a slow and steady pace, with reasons including the continued stability of the U.S. economy, a balanced labor market, and ongoing inflation deceleration.

The Chicago Mercantile Exchange's FedWatch Tool shows that the probability of a 25 basis points and 50 basis points rate cut by the Federal Reserve in November is essentially evenly split, and then a further substantial rate cut is expected in 2025.

The battle against inflation! Is the Federal Reserve close to declaring victory?

The Federal Reserve is tasked with the dual mandate of achieving full employment and price stability.

After two years of the war against inflation, the inflation rate in the USA dropped to 2.5% in August, the lowest level since February 2021. Most officials believe that the Federal Reserve has made significant progress in balancing these two major goals.

Minneapolis Fed President Kashkari published an article on Monday expressing support for the decision to cut interest rates by 50 basis points last week. Inflation has significantly cooled down and is close to the Federal Reserve's 2% target, while the labor market is beginning to show signs of weakness.

In my opinion, the risk balance has now shifted from rising inflation to rising unemployment.

Kashkari stated that the policy remains tight, and it is expected that future rate cuts will be smaller, with another two cuts of 25 basis points expected within the year.

On the same day, Atlanta Fed President Bostic stated that the Federal Reserve has made "substantial progress" in combating inflation, while the risks in the labor market have increased, but there is still no "red light".

Although inflation is still above the Federal Reserve's target, it is estimated that at the current pace, inflation will reach the Federal Reserve's target in the next year. Federal Reserve Governor Waller stated last week:

This makes me believe (a 50bp rate cut) is the right course of action.

Of course, not all Federal Reserve officials believe that the task of combating inflation has been completed.

Federal Reserve Governor Bowman warned that inflation may rebound in the coming months, and she is more inclined to cut interest rates by 25 basis points in September, also the only director to vote against a 50 basis point rate cut during the September monetary policy meeting.

Where is the end point of interest rates? It depends on inflation and employment.

Federal Reserve Chairman Powell described the 50 basis point rate cut as a 're-calibration' of monetary policy at the monetary policy press conference, rather than a panic measure taken to avoid an economic recession.

Of course, if there is no risk of economic recession in the United States, the Federal Reserve indeed does not need to urgently cut interest rates significantly.

The GDPNow model from the Atlanta Federal Reserve currently estimates that the US GDP will grow by 2.9% year-on-year in the third quarter, indicating that the economy remains robust. In addition, the Federal Reserve's September forecast indicates that by 2027, the actual GDP growth rate in the United States will reach 2% per year, with the highest unemployment rate only at 4.4%.

However, there are signs of deterioration in the labor market. In August, the unemployment rate rose from its lowest point in half a century at 3.4% to 4.2%.

According to the dot plot released by the Federal Reserve in September, the Fed will cut interest rates by a total of 100 basis points this year (meaning a further 50 basis point cut later in the year), and then cut another 100 basis points by the end of 2025, bringing the target rate to a range of 3.25%-3.5%.

There is still disagreement within the Federal Reserve regarding the neutral interest rate, but Bostic believes this is not important. He stated:

At least in my opinion, it was the case at the September meeting. Regardless of where the neutral interest rate is, I do not know who would reasonably argue against the point that the interest rate is far above the neutral level.

Gurzbie et al. believe that as the inflation rate continues to decline, the real (or inflation-adjusted) federal fund rate has increased, effectively making policy more stringent.

Fed Governor Kugler said on Wednesday:

Although future actions will depend on the inflation, employment, and economic activity data we receive, if the situation continues to evolve as it has so far, further rate cuts would be appropriate.

Will there be another 50 basis point rate cut in November? Focus on the next two non-farm payroll reports.

The next FOMC meeting will be held on November 6-7, just days after the US election. As usual, Fed officials have left plenty of room for the next steps.

Woll stated that if the unemployment rate worsens and inflation continues to slow further, there may be another 50 basis points rate cut. On the other hand, if inflation rebounds, the Fed may pause rate cuts.

The focus now is on the next two (September and October) non-farm payroll reports, especially the October non-farms. The reporting period coincides with the blackout period before the FOMC policy meeting, making it crucial for rate decisions.

Deutsche Bank's chief economist in the usa, Matthew Luzzetti, wrote on Wednesday:

While overall data is always important, the upcoming labor market data will give the Federal Reserve more confidence, believing that the weak trend in the labor market is stabilizing.

Luzzetti said that if the unemployment rate exceeds the Fed's forecast of 4.4% and nonfarm payroll remains around or below 0.1 million per month, there will certainly be a further 50bp rate cut in November. A larger downward revision in employment numbers would also provide reasons to accelerate the pace of rate cuts.

Editor/Rocky