The Fed’s biggest interest rate call in years will take place on Wednesday. This is what you can expect

For all the hype that accompanies them, Federal Reserve meetings are usually fairly predictable affairs. Policymakers telegraph their intentions in advance, the markets react, and everyone has at least a general idea of ​​what will happen.

Not this time.

This week’s meeting of the central bank’s Federal Open Market Committee has an unusual air of mystery. While markets have collectively concluded that the Fed will cut rates, a heated debate rages over how far policymakers will go.

Will it be the traditional rate cut of a quarter of a percentage point or 25 basis points, or will the Fed take an aggressive first step and go to 50 or a half point?

Fed watchers are uncertain, creating the possibility for an FOMC meeting that could have even more impact than usual. The meeting ends on Wednesday afternoon, with the publication of the Fed’s interest rate decision at 2 p.m. Dutch time.

“I’m hoping they’ll cut 50 basis points, but my guess is they’ll cut 25. I’m hoping for 50 basis points because I think rates are just too high,” said Mark Zandi, chief economist at Moody’s Analytics. “They have achieved their mandate for full employment and inflation back on target, and that is not consistent with a fund rate target of five and a half percent. So I think they need to normalize interest rates quickly and they have a lot of room to do that. .”

Prices in the derivatives market for what the Fed will do have been volatile.

Until late last week, traders had held on to a 25 basis point cut. Sentiment suddenly changed on Friday, leaving half a point on the table. As of Wednesday afternoon, Fed Funds futures traders had priced in a roughly 63% chance of a bigger move, a relatively low level of conviction from previous gatherings. One basis point is equal to 0.01%.

Many on Wall Street continued to predict that the Fed’s first move would be a more cautious one.

“While the tightening seemed to work, it didn’t work exactly the way they thought it would, so easing should be viewed with just as much uncertainty,” said Tom Simons, U.S. economist at Jefferies. “So if you’re unsure, don’t rush.”

“They need to take action quickly here,” Zandi said, expressing a more forgiving view. “Otherwise they run the risk of something breaking.”

The debate in the FOMC conference room should be interesting, with unusual division among officials who generally voted in unison.

“I suspect they are divided,” former Dallas Fed President Robert Kaplan told CNBC on Tuesday. “There will be some around the table who, like me, feel like they’re a little late, and they’d like to be on their front foot and would rather not spend the entire fall chasing the economy. others are who, from a risk management perspective, simply want to be more cautious.”

In addition to the 25 vs. 50 debate, this will be an action-packed Fed meeting. Here’s an overview of what’s on tap:

The FOMC has kept its fed funds rate within a range of 5.25% to 5.5% since the last increase in July 2023.

That’s a 23-year high and has remained there even as the Fed’s preferred inflation measure fell from 3.3% to 2.5% and the unemployment rate rose from 3.5% to 4.2% over that period.

In recent weeks, Chairman Jerome Powell and his fellow policymakers have left no doubt that a cut is coming at this meeting. Deciding to what extent will require a trade-off between fighting inflation and bearing in mind that the labor market has slowed significantly in recent months.

“For the Fed, it comes down to deciding which is a bigger risk: reigniting inflationary pressures if they cut by 50 basis points, or threatening a recession if they cut by just 25 basis points,” said Seema Shah, chief strategist at Principal Asset Management. said in written commentary. “Because the Fed has already been criticized for reacting too slowly to the inflation crisis, it will likely be wary of being reactive rather than proactive to the risk of a recession.”

Perhaps just as important as the rate cut are the signals that meeting participants are sending about where they expect rates to go from here.

This will be done via the ‘dot plot’, a grid in which each official will indicate how he sees things unfolding in the coming years. The September plot offers the first prospects for 2027.

By June, FOMC members had implemented just one rate cut through the end of the year. That will almost certainly accelerate, with markets pricing in the equivalent of five or 1.25 percentage points of cuts (assuming 25 basis point moves) with just three meetings to go.

All told, traders see the Fed hacking rates next year, shaving 2.5 percentage points off the current overnight rate before stopping, according to the CME Group report. FedWatch benchmark for futures contracts.

“That feels overly aggressive unless you know the economy is going to weaken significantly,” Zandi said of the market outlook. Moody’s expects a quarter-point cut at each of the three remaining meetings this year, including this week’s.

The scatter plot is part of the FOMC’s Summary of Economic Projections, which also provides unofficial forecasts for unemployment, gross domestic product and inflation.

The biggest adjustment for the SEP will likely come from unemployment, which the commission will almost certainly increase from the year-end forecast of 4.0% in June. The unemployment rate currently stands at 4.2%.

Core inflation, which was set at 2.8% for the year in June, is likely to be revised downwards, having last stood at 2.6% in July.

“Inflation appears to be on track to remain below the FOMC’s June projections, and the higher readings early in the year increasingly look more like residual seasonality than reacceleration. An important theme of the meeting will therefore be a shift in focus to labor market risks.” Economists from Goldman Sachs write this in a note.

In addition to adjustments to the dot plot and the SEP, the statement after the committee meeting will need to change to reflect the expected rate cut, along with any additional guidance the committee will add.

The statement and SEP, released at 2:00 PM ET, will be the first things the market will react to, followed by the Powell press conference at 2:30 PM.

Goldman expects that the FOMC “will likely revise its statement to be more confident about inflation, portray risks to inflation and employment as more balanced, and reemphasize its commitment to maintaining maximum employment.”

“I don’t think they’re going to be particularly specific about any kind of forward guidance,” said Simons, the Jefferies economist. “Forward guidance at this point in the cycle is of little use if the Fed doesn’t really know what they’re going to do.”