Warmer-than-expected readings on consumer prices – and in some wholesale prices – over the past two days have led markets to trade on a higher likelihood that the Federal Reserve will opt for a smaller, more conservative cut in interest rates at its meeting of September
A bigger cut could cause the stock to pull back.
As of Thursday, investors put the odds of the Fed cutting rates by 50 basis points at its meeting next week at just 15%, down from the 44% chance seen a week earlier, according to the CME FedWatch tool Tool.
Some strategists said a 25 basis point cut would be a more welcome signal from the Federal Reserve.
Yardeni Research chief market strategist Eric Wallerstein reasoned that the Fed would likely not cut by more than 25 basis points “absent recessionary conditions or an emerging financial crisis.”
Read more: What the Fed’s rate decision means for bank accounts, CDs, loans and credit cards
“For everyone who is calling for a 50 basis point cut, I think they should really reconsider the amount of volatility that would cause in the short-term funding markets,” Wallerstein told Yahoo Finance. “It’s not something the Fed wants to risk.”
According to Wallerstein, while the most recent jobs report showed continued signs of a slowdown in the labor market, economists largely reasoned that it did not reveal the substantial cooling that many believed would be needed to trigger a deeper Fed cut. The risk is that a significant deterioration in the labor market signals a recession.
Meanwhile, Wednesday’s Consumer Price Index (CPI) report showed that on a “core” basis, which strips out the more volatile costs of food and gas, prices in August rose 0.3% on the month earlier, above Wall Street expectations of a 0.2% increase.
“The unpleasant news on inflation will slightly distract from the Fed’s renewed focus on the labor market and make it more likely that officials will take a more measured approach to easing, starting with 25. [basis point] cut next week,” U.S. economist Michael Pearce, deputy director at Oxford Economics, wrote in a note to clients on Wednesday.
Some on Wall Street also pointed out that a 50 basis point interest rate cut could create a more ominous signal about the health of the US economy than the central bank wants to portray.
“A cut of 50 basis points would smack of panic, and it’s almost like we’re completely behind the curve at this point,” Jennifer Lee, senior economist at BMO Capital Markets, told Yahoo Finance.
DataTrek co-founder Nicholas Colas analyzed every Federal Reserve rate cut cycle since 1990. Among the five rate cut cycles during that time period, both times the Fed started its cycle with a 50 basis point cut (in 2001 and 2007), a recession soon. followed
“While the data here is thin, there is something to be said for pairing an initial 25 basis point cut with a 50 basis point mid-cycle policy correction, as it signals that the Fed is too far behind the curve to avoid a recession.” , wrote Colas. in a note to clients Wednesday morning. “Chairman Powell and the rest of the FOMC certainly know this story. Their first cut will almost certainly be 25 basis points.”
As of Wednesday morning, markets expect 100 basis points of cuts from the Federal Reserve this year. More clues about the Fed’s thinking will come on Sept. 18 when the Federal Reserve releases its Summary of Economic Projections, including its “dot plot,” which charts policymakers’ expectations of where interest rates might go. in the future
Wallerstein reasoned that if the total amount of Fed cuts this year falls short of market expectations, that’s not necessarily bad for stocks.
“If those rate cuts take out prices because growth is stronger than expected and GDP is strong in the third quarter and labor market indicators are not too bad, and we continue to see consumer spending. [increasing]then stocks will have more room to run as earnings continue to grow,” Wallerstein said.
Josh Schafer is a reporter for Yahoo Finance. Follow him on X @_joshschafer.
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