Source: CME Group
This suggests that the markets are not sure how big a step the Fed will take to start the rate cut cycle. Accordingly, we can say that this issue, which has become a focal point, may cause deep turmoil in the markets at 18:00 (UTC) on Wednesday evening.
Considering the recent statements of FOMC officials and macro indicators, we see a 25 bps rate cut as more likely. In addition, we can say that one of the factors supporting this view is that the FED will include the reaction of the markets to the size of the rate cut in its calculations. We can explain this situation as follows.
In recent months (especially in August and early September) we have seen markets driven by concerns about a recession and also by euphoria over expectations of the size of the Fed’s rate cuts. These two different pricing behaviors operate on different emotions. Recession fears cause bad macro data to negatively impact markets. However, in the absence of recession fears, bad economic data can support the view that the Fed will cut rates faster, which can have a positive impact on markets (Bad data-good market and Bad Data-Bad market models).
The FED’s 50 basis point cut has the potential to have the opposite effect on the markets. In other words, a 50 basis point cut could reinforce the idea that things are really bad in the economy and that’s why the FED pressed the red button. We think that FOMC officials are aware of this situation. Therefore, we can assume that a 25 basis point rate cut by the FED is a more likely scenario in terms of both data, reality and market psychology.
But let’s not forget that markets are full of surprises and it is good to be prepared for every situation.
Remaining Meetings of the Year
While we will see the rate cut, the markets will also focus on the FOMC’s expectations on macro data and its thoughts on the level of interest rates going forward, which will be announced with this decision. These figures will also be available in the documents that will be published along with the rate decision.
Source: CME Group
Markets anticipate that the FOMC will lower interest rates to the 4.00-4.25 range by the end of the year. This forecast suggests a cut of approximately 125 basis points. It also indicates that the Fed may implement a significant “jumbo” cut exceeding 25 basis points in its remaining three meetings, including the upcoming September 17-18 session. Typically, the FOMC makes adjustments in increments of 25 basis points. However, during recessions, crises, or events like COVID-19, they have taken larger actions.
We believe the landscape will shift after September 18. While a 50 basis point cut is feasible, larger cuts may signal to the markets that economic conditions are deteriorating. The “dot plot,” which illustrates the expectations of FOMC officials regarding interest rates, could significantly alter these expectations.
Remarks by Chairman Powell
Following the announcement of these decisions and data at 18:00 UTC, Fed Chairman Powell will address the public at 18:30 UTC. He will explain the rationale behind the decisions and then open the floor to questions.
This interaction is likely to amplify market volatility. Investors will closely watch for hints from Powell regarding the FOMC’s stance on potential future rate cuts, especially since many developments will have already unfolded.
How Will This Affect the Markets?
Analyses
Investors face a challenging decision-making environment due to the lack of consensus on the Fed’s intended cut. This uncertainty leads to a diverse array of investor positions based on various scenarios. Once the decisions are announced, these positions will undergo significant adjustments. This will result in notable price movements across financial assets.
The key moment for pricing may occur at 18:00 UTC, when the magnitude of the rate cut and the expectations of FOMC officials will become clear. Market participants will observe different scenarios and corresponding pricing behaviors.
If the Fed opts for a 25 basis point cut, investors who anticipated a 50 basis point reduction may quickly rebalance their portfolios. This reaction could initially strengthen the dollar and weaken digital assets. However, it wouldn’t be surprising to see the dollar correct downwards shortly thereafter. Such a rate cut would signal that the Fed isn’t overly concerned about a recession or the labor market’s health. This could potentially increase risk appetite.
On the other hand, if the Fed cuts by 50 basis points, we can expect the dollar to weaken initially. This could spark a short-term rally in digital assets. Nonetheless, this scenario would also suggest that the Fed is worried about the US economy’s health, which could dampen risk appetite. Thus, the dollar might experience initial losses followed by an upward trend. Meanwhile, digital currencies could decline.
Conclusion
While we’ve outlined potential market reactions based on these scenarios,
we must acknowledge the complex pricing patterns that may arise. The economic projections and “dot plot” released alongside the interest rate decision will add another layer of complexity.
Consequently, these scenarios might not hold true in the rapidly changing pricing landscape. Investors should exercise caution and avoid making hasty new positions immediately after the announcements. Paying close attention to existing positions can help mitigate potential losses.
