FOMC Meeting: Time To Hit Pedals Of Rate Cut On September 18? Here's Why This US Fed Policy Is Delicate!

Fed Policy: The runway is set, and all eyes are on the Federal Reserve whose holding the elevators of multi-decadal high interest rates of the United States, to begin its first descent since 2020. It's been a long journey, the key fund rates of the US have been up above the roof since post-Covid. And a dive, either moderate or huge in quantum, the Fed policy decision on September 18 is crucial and delicate for both the economy and the market.

The possibility of a rate cut is inevitable, but it is the size of a rate cut that matters. Traders, market experts and economists believe that the Fed has already delayed in catching up to the cooling in inflation, and while the probability of a 25 bps rate cut is high, a surprise and aggressive 50 bps cut is also welcoming.

Greg Mcbride, CFA, Chief Financial Analyst For Bankrate said, "Cutting interest rates at this point is not about pressing on the gas pedal, it's about lifting the foot off the break. We're entering a falling-rate environment, but that doesn't mean we'll be in, or even end up in a low-rate environment."

Bankrate's note pointed out that economists say the Fed has two main options for its first interest rate cut: It can reduce borrowing costs by a smaller quarter of a percentage point - or it can opt for a bigger half-point cut out of the gate.

In the Jackson Hole meeting, Fed's chair Jerome Powell hinted at keeping the options open for the size of the first rate in four years in the September 2024 policy.

Overall, economists believe the time for the elevators of 23-year high interest rates has arrived for adjustment.

The reason behind the Fed's aggressive rate hikes which began in early 2022, was an attempt to curb the frenzied surge in the economic indicator inflation . The US inflation rate went from 2.6% in March 2021, to more than doubling to 7% in December 2021 and shooting up to more than four-decades high of 9.1% in June 2022 after Russia invaded Ukraine which led to global supply disruption.

9.1% inflation, highest since November 1981, was an sore to not just financial market, but overall economy as well.

Not just that from May 2020, when inflation was merely at 0.1%, the US consumer price rate catapulted by 91 times by June 2022-end, which was enough for the aggressive rate cycle to begin. Fed has kept the rates unchanged at over two-decades high since July 2023, to let inflation ease and examine the impact of rate hikes on business activity.

The last time the Fed made an aggressive rate cut was in March 2020 by a mind-boggling 150 bps, bringing the fund rates to zero levels. This was done to tackle the shockwaves of Covid-19 on the economy. The rates were unchanged from 0% to 0.25% from April 2020 to February 2022, before the hike-cycle kicked in.

With supply-chain distress, economic uncertainties, and geopolitical tensions that spread like wildfire globally, the Fed started the rate hike cycle with a moderate 25 bps increase in March 2022, until the hikes spiraled to aggressive by 50 bps to 75 bps. From March 2022 to July 2023, the Fed has hiked rates by 525 basis points, taking key fund rates to 5-1/4 to 5-1/2 per cent.

Will the Fed follow a similar pattern, begin soft and go aggressive in rate cuts?

McBride said, "A case could be made either way," adding, "The economy is not falling apart, but the case for a 50 basis point cut is to take out some insurance, so the Fed isn't falling behind the curve."

Polish bank ING who initially expected an aggressive cut of 50 bps from the Fed on September 18, is now expecting a 25 bps cut.

According to ING, "We favoured a larger move as an insurance policy against the prospect of more significant job weakness in the future, but the most recent jobs report was not as weak as feared, and August core CPI came in hotter than hoped at 0.3% MoM."

ING's note added, "Given this backdrop, we have to admit that 25bp looks like the most probable outcome. The market was also sensing this with 30bp priced in the wake of CPI - effectively a 25bp is baked in with a 20% chance that the Fed goes for a 50bp cut. Yet, as of Friday morning, a flurry of wagers on a larger move has seen the pricing shift to 36.5bp - a 46% chance of a 50bp cut."

The Polish bank believes it will be a close call though. It agrees that there is plenty to justify such a move. Business surveys paint a gloomy picture of slowing activity and hiring.

Whether 25 bps, 30 bps or a 50 bps cut, Sebi-registered Equity Investment Analyst and Author Finance, Chirag Jain believes the rate decision is delicate.

Jain explains the economic and market context for Fed rates, and why there is a need for a balance between fostering maximum employment and maintaining price stability.

In an economic context, Chirag added, "Recent data indicate that inflation is nearing pre-pandemic levels, while the labour market is softening, with the unemployment rate rising to 4.1%. Although this rate is still below the Fed's estimated natural rate of unemployment, the increase signals potential concerns about economic momentum. Despite inflation being somewhat elevated, making the Fed cautious, there is a consensus that current conditions support a move towards easing monetary policy without igniting significant inflationary pressures."

Giving an outlook, Chirag said, "The U.S. economy continues to grow solidly, with a forecasted growth rate of 2.5% for 2024. Strong economic performance might lead the Fed to keep rates higher for longer unless evidence shows that elevated rates are adversely affecting growth.

The analyst further explained that current market indicators such as interest rate futures are priced at 5.25%, and the bond yield is around 3.6%, suggesting a strong likelihood of a rate cut, possibly by 50 basis points.

Overall, Chirag said, "the Fed's upcoming decision will be a delicate balance between fostering maximum employment and maintaining price stability amid a complex economic landscape.

How the market could react to Fed policy decisions. Swapnil Aggarwal, Director, VSRK Capital said, the market's reaction will depend on the motivations behind the Fed's decision. If the rate cut is in response to concerns about a slowing economy or rising unemployment, the positive market effect could be muted. Conversely, if the Fed is cutting rates due to low inflation and a stable growth outlook, markets may rally in response to the more favourable borrowing environment. All eyes are on the Fed as it navigates this complex economic landscape.

Historically, Aggarwal said, a rate cut has often fueled optimism in the stock market, as it reduces corporate borrowing costs and increases consumer spending power.