FED PREVIEW: 50 Basis-Point Rate Cut On the Cards on Sept 18? All Eyes On FOMC Meet

The US Federal Reserve is widely expected to cut its benchmark interest rates on September 18 but the key question is will it be a 25 or 50 basis point cut as markets think that there is a bigger chance that the Fed will move aggressively.

The CME FedWatch tool shows that interest rate traders are currently pricing in a 60 percent probability of a 50 basis point cut on Wednesday while top economists more or less expect a 25 basis point reduction from its current fed funds rate of 5.25-5.50 percent.

Financial markets worldwide have been keeping a close watch and while a rate cut is almost already priced in, the intensity of the cut will possibly determine the direction of the stock market in the coming days.

The increasing bets by the traders for a bigger rate cut reflect on the fact that the US central bank may have to move quickly as labour market shows signs of weakness. Economists however expect the Fed to do a soft landing and reduce the benchmark policy rate for the first time in four years.

"We expect the Fed to cut rates by 25 bp at its September meeting. The broad message is likely to be cautiously optimistic. The base case is still a soft landing, but the Fed is vigilant to downside risks to its employment mandate," said Aditya Bhave, US economist at BoFA Global Research.

"And importantly, rate cuts are not on a pre-set path. The Fed will make decisions on a meeting-by-meeting basis, based on the incoming data. Translation: super-sized cuts are on the table at future meetings."

What will be worth noticing is how many policy-makers voted for a 50 bps cut in the Federal Open Market Committee meeting on September 17-18. Inflation is still relatively high and the job market is not as strong as expected.

Either be 25 bps or 50 cut, it will be done for the first since 2020. In the opinion of Raj Patel, CMO at MintCFD, overall, inflation appears to have been successfully tamed but, with housing inflation still refusing to moderate as quickly as hoped, it hasn't been completely vanquished. He said, "Under those circumstances, we expect the Fed to take a measured approach to cutting interest rates."

How Indian Stock Market Will Likely React To the Rate Cut

Most of it is priced in. Markets are entering a new phase with the possible rate cut by the Fed, according to a Nuvama research note reported by Mint. It said while the theory proposes that lower interest rates boost equity valuations, history paints a more complicated picture. Past rate cuts, in 2001, 2007-08, and 2019, saw varied market reactions, and Nuvama said similar caution is warranted this time around as well.

Fed cut interest rates on September 18, 2007, just three months before the Great Recession. Stock markets around the world collapsed, unemployment escalated, and the big elephant 'recession' stared straight in the eye after the infamous collapse of British banking giant, Lehman Brothers. Data from the Federal Reserve showed that the 2007-09 economic crisis was deep and protracted enough to become known as "the Great Recession" and was followed by what was, by some measures, a long but unusually slow recovery.

In response to weak economic conditions in 2008, the FOMC lowered its target for the federal funds rate from 4.5 percent at the end of 2007 to 2 percent at the beginning of September 2008. As the financial crisis and the economic contraction intensified in the fall of 2008, the FOMC accelerated its interest rate cuts, taking the rate to its effective floor - a target range of 0 to 25 basis points - by the end of the year, as per the FOMC data.

Is the US on the path of yet another great recession period? As per Statista data, by December 2024, it is projected that there is a probability of 62.9 percent that the United States will fall into another economic recession. This reflects a sharp increase from the projection of the preceding month i.e. 51.84% in November 2024.

According to Murthy Nagarajan, Head-Fixed Income, Tata Asset Management, the Federal Rate cut is widely expected in the market. The FOMC members expectations of the trajectory of the economy will be of interest to the market participants. Rate cuts in US normally led to weakening of the dollar, rally in emerging markets, higher commodity prices.

He added, "This time around given Chinese slowdown rally in commodity prices looks difficult. Global developed markets like Eurozone, Canada have already started cutting rates before the Federal Reserve which should restrict dollar weakness. The effect of Fed cutting rates could be bullish for debt markets as the interest rate differential would increase and led to more flows in debt markets."

Noteworthily, a 25 bps may likely lead to muted results in the market, and however, Patel added, "a major rate cut in the magnitude of 50 bps could generate negative reactions since it might show that the Fed is signaling major concerns about the economic outbreak. Indicators such as retail sales, consumer confidence index, and services PMI are on a positive note. The Fed is focusing more on employment as the average US unemployment rate over the last three months, up to July, has increased by 0.5% as compared to the lowest point in the past year."

(Additional reporting by Pooja Jaiswar)