US Fed Rate Cut: Will the Federal Reserve surprise markets by cutting rates by 0.5%?

The big week in the global stock market has arrived. The Federal Reserve FOMC meeting is underway and the rate cut decision is to be announced tomorrow. FOMC meets over two days – September 17-18 and the US Fed chair Jerome Powell announces the monetary policy decisions on September 18.

The US Federal Reserve is expected to decrease interest rates for the first time after keeping the benchmark lending rate at a two-decade high of between 5.25 to 5.50 percent for the previous 14 months.

“FOMC are set to reduce the target range for the fed funds rate by 25bp after the September meeting, bringing rates to 5.00% – 5.25%, in what is set to be the first rate cut since March 2020,” says Michael Brown Senior Research Strategist at Pepperstone.

The general consensus in the market is the Fed will cut rate by a quarter percentage. However, some also believe that the quantum could be higher and the Fed may cut by 0.5%.

The US central bank’s September 18 meeting may decide to cut its benchmark federal funds rate by 25 basis points or 50 basis points. However, data suggests the Fed’s fight against inflation is not over yet. Core inflation rose 0.3% in August, slightly above expectations, mainly due to rising housing costs. Some investors worry that aggressive rate cuts could risk reinforcing inflation.

“The key debate here appears not to be one of whether the Fed will deliver a 25bp, or a 50bp but instead centres around the pace at which the fed funds rate will return to a more neutral setting. Most estimates see the neutral rate, in nominal terms, at around 3%, leaving 200bp of easing to be delivered before such a level is achieved,” says Brown.

For markets, the updated ‘dot plot’ is likely to be of most interest. At present, the median dot points to just 25bp of easing being delivered this year, followed by a further 100bp of cuts in 2025. “This time around, the median dot will likely point to 75bp of cuts this year – broadly ‘marking to market’ the FOMC’s expectations – followed by a further 100bp of cuts in 2025, leaving the fed funds rate at 3.00% – 3.25%, its neutral level, by the end of next year. The longer-run dot is likely to remain unchanged, at 2.75%,” says Brown.

FOMC meeting on September 17-18 will also see the release of the Summary of Economic Projections showing the state of the economy. Fed officials and Chair Powell have clarified that their focus is now on the labor market, not inflation. Unemployment ticked higher, having risen to 4.3% in July, its highest level since October 2021, before pulling back a touch to 4.2% in the August report.

Any aggressiveness shown by the Fed in cutting rates may reignite inflation and a delay in rate cuts may damage the economy.

Therefore, more than the rate cut decision, it will be the press conference of Powell that will keep traders and investors on the edge of their seats on September 18.

Clear guidance from the fed chief will be important. “Financial markets may prove to be somewhat disappointed by the lack of concrete policy guidance,” says Brown.

Chair Jerome Powell may maintain a dovish stance during the press conference, allowing room for potential larger rate cuts in response to deteriorating economic data. From this point on, labor data and consumer demand—rather than inflation — take center stage.

“Historically, in the 12 months following the start of interest rate cuts by the Federal Reserve at the end of a rate-hike cycle, the average return on U.S. stocks has been 11% above inflation,” says Hani Abuagla Senior Market Analyst at XTB MENA. Will the run continue for US stock market this time, only time will tell.