Will the Fed Go Big or Start Small?

Will the Federal Reserve’s Federal Open Market Committee cut the federal funds rate this Wednesday/? It’s about as close to an absolute “yes” as you can find in economics. That’s been the case since Fed Chair Jerome Powell said, “The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”

What does that mean/? No one outside the central bank has any idea before the September meeting. The confusion has been like a seesaw. Look at the probability changes implied by the 30-day fed funds futures prices on the CME Group’s FedWatch site and the changes are like compressed whiplash.

On August 5, 2024, on the recent equity market crash, the chance of a 25-basis-point change was 15% and a 50-basis-point change was 85%. By Monday, August 19, the chance of a 50-basis-point-cut was 24% and a 25-basis-pint cut was 76%.  A week later a 25 basis point cut went down to 68%, and a 50 basis point reduction ticked up to a 36% chance. Monday, September 9 saw 70% and 30% for 25 to 50 basis points respectively. And by Monday, September 16 — two days before the decision — odds were 50-50.

MarketWatch reports that economists see “rather poor” communication on the part of the Fed at the root of the uncertainty and unusual thrashing of perceived probabilities. “This should be a point of welcome relief to celebrate — and it is, in part,” the outlet said was included in a note to clients by Derek Holt, vice president of Scotiabank Economics. “What unfortunately mars the occasion is that the Fed is communicating rather poorly with markets in a way that is driving elevated market volatility around size and pace issues.”

Ethan Harris, former head of global economics research at Bank of America Securities, told MarketWatch in an email that the Fed has become less predictable in its strategies, adding to general uncertainty.

Some former Fed officials, who are taken as having insight into the decision process, now call for a larger cut. Steven Kamin, senior fellow at the American Enterprise Institute and a former director of the Division of International Finance at the Federal Reserve Board, last week told CNBC that “the economy is slowing somewhat and inflation is clearly on the way down” and that a 50-basis-point cut would be “reasonable.”

Former New York Federal Reserve President Bill Dudley said last week at the Bretton Woods Committee’s annual Future of Finance Forum in Singapore, “I think there’s a strong case for 50, whether they’re going to do it or not,” according to Reuters. He argued that rates were already 150 to 200 basis points above the neutral rate, which is the one where monetary policy neither speeds nor slows the economy.

At this point, the only certainty will be when the Fed announces the size of the rate cut on Wednesday.