The Federal Reserve is expected to announce a substantial rate cut at its meeting this Wednesday, with market sentiment increasingly favoring a 50 basis-point reduction. This marks a significant shift from last week when the probability of a larger cut was only 14%. According to data from the CME Group’s FedWatch Tool, there is now a 57% likelihood of a 50 basis-point cut, up from 50% on Friday, as investors contend with unprecedented uncertainty surrounding the Fed’s next move.
Image: CME FedWatch Tool
The decision holds particular weight given the current economic environment. “This is a weighty decision for the Fed, as recent market volatility is tied to fluctuating expectations about rate cuts,” explained Ed Yardeni, founder of Yardeni Research. The Federal Reserve is balancing the need to ease financial conditions while avoiding triggering further instability in bond and equity markets.
Since July, the federal funds rate has been held at a range of 5.25% to 5.5%, its highest level since 2001, following a series of hikes to combat inflation. However, with inflation having moderated significantly in recent months, the conversation has shifted to whether the Fed will move to lower borrowing costs, especially as labor market performance continues to disappoint.
Market Split on Size of Cut
Economists and strategists are divided on the expected size of the rate cut. Some, like JPMorgan’s chief economist Michael Feroli, expect a 50 basis-point cut, stating that the Fed will “do the right thing” by making a decisive move to stimulate the economy. Others, like Goldman Sachs’ chief economist, believe a more modest 25 basis-point cut is likely, arguing that larger cuts typically come in times of more obvious economic distress.
Vijay Valecha, Chief Investment Officer at Century Financial, weighed in on the potential global ramifications of the Fed’s decision, noting how it might impact currency markets: “If the Federal Reserve opts for a larger interest rate cut this week, the euro could aim for a new high for the year. The disparity in rate-cutting trajectories between the Fed and the ECB is key, with the Fed having more room for significant reductions.”
Impact on the Dollar and Global Markets
With the U.S. dollar already losing upward momentum following the release of softer inflation data, many experts expect further downside pressure if the Fed follows through with a rate cut. Mohamed Hashad, Chief Market Strategist at Noor Capital, noted: “The slowdown in consumer prices has fueled speculation that the Fed will start cutting rates in September. Inflation retracement is a positive sign for the Fed, indicating they are nearing their 2% inflation target.”
Hashad added that market optimism has grown, as many now expect the Fed to begin normalizing monetary policy through a series of rate cuts. A 50 basis-point cut would further erode the dollar’s strength, with global investors already adjusting their portfolios to reflect the impending policy shift.
Positioning for a Rate Cut
Investors are increasingly focused on positioning their portfolios ahead of the expected rate cuts. Charu Chanana, Head of FX Strategy at Saxo Bank, emphasized the importance of adapting to this new environment. “With the Federal Reserve expected to cut rates, it’s time to consider how your portfolio is positioned for this shift,” she said. ETFs provide a flexible way to make adjustments, and Chanana suggests considering short-duration bonds and inflation-protected securities as part of a strategic approach to the current landscape.
As the Federal Open Market Committee (FOMC) prepares for its decision, market expectations for the rest of the year suggest further cuts may be on the horizon. The FedWatch Tool currently prices in a total of 125 basis points of cuts by year-end, with rates potentially falling to a range of 4% to 4.25%. This anticipated pivot has left investors watching closely to see how the central bank will navigate the delicate balance between supporting the labor market and maintaining inflation control.
Navigating Economic Crosscurrents
As the Fed edges toward an era of rate cuts, both domestic and global markets are bracing for the consequences. A rate cut, especially a significant one, will likely have ripple effects across various sectors, from real estate and business loans to international currency markets. If the Fed opts for a more aggressive cut, it may ease financial conditions but also reshape inflation-adjusted yields, potentially giving the euro an additional boost.
“The euro is in a position to capitalize on this policy disparity between the Fed and the ECB,” Valecha noted, adding that U.S. Treasury yields have fallen at a faster pace compared to German rates, supporting the euro’s rise by nearly 4% against the dollar.
With much riding on the Fed’s decision, markets will be watching closely for signals of future policy direction. The outcome of Wednesday’s meeting will likely set the tone for global economic sentiment as 2024 progresses.
