Outlook for the Fed’s FOMC Meeting
As we wait for the Fed to make its widely anticipated interest rate decision, this is one that could go either way. The debate is not whether the Fed will cut rates but by how much.
I take a logical or what I call a common sense approach to trading. What this means is I view trading as a puzzle and look for the pieces to fit together.
While reactions to news events can sometimes surprise and defy logic, markets generally eventually settle around a more logical response.
This brings up the next key news event, Wednesday’s Fed rate decision. As I noted, the only uncertainty is not if it will cut rates but by how much, 25 bps or 50 bps?
Markets see it as a 50/50 bet so let’s see what logic says.
Economic Data Calendar
A Case for 50 bps
1) Inflation has slowed and unemployment, while still positive has cooled.
2) Risk of falling behind the curve by not having cut rates sooner
3) Better to front load rate cuts to have the maximum impact.
A Case for 25 bps
1) A larger cut could send the wrong signal, which is the Fed sees a greater risk to the economy and for a recession than is generally perceived.
2) Past history shows a risk of cutting rates too soon and reigniting inflation.
3) A larger rate cut could be seen as helping the Democrat candidates so close to the November 6 Â presidential election,
So, what does logic say?
While a case can be made for either a 25 or 50 bps rate cut, logic says there is a stronger one for a smaller reduction in rates. This would give the Fed time to see more data and not raise expectations of more aggressive rate cuts. The next FOMC decision not due until one day after the election.
Market reaction
Should the Fed cut rates by just 25bps, any negative market reaction on disappointment would be illogical as it doesn’t mean there will not be larger cuts down the road. It would also suggest the Fed sees a greater risk of a soft landing and  less risk of a recession in its outlook.
On the other hand, logic says the reaction to a 50bps rate cut would be swift as markets would likely then price in expectations of larger rate cuts. It could also raise some yellow flags that the Fed sees the economic outlook as more fragile than generally perceived but that would be for a future discussion.
In any case, hold on to your seat belts as there will be volatility no matter what the Fed decides.
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