Fed Resolution Preview: The current pricing of rate cuts is too aggressive, and a 25 basis point rate cut could undermine the market.
The Fed is almost certain to cut rates for the first time in over four years tonight, but it is unknown whether policymakers will choose to cut rates by 50 basis points or a smaller amount. Currently, the Intrerest Rate futures market reflects a more than 60% probability of a 50 basis point rate cut. Fed Chairman Powell has said that this is their top priority as inflation approaches the Fed's 2% target. However, a 25 basis point rate cut would be more in line with the Fed's past practice of starting a loose cycle outside of a crisis. Stock options pricing indicates that the S&P 500 index could experience fluctuations of about 1.1% on Wednesday. The recent pump in the US stock market makes it difficult for the market to cope with disappointment if the Fed's rate cut is smaller.
KPMG Chief Economist Diane Swonk wrote that although a 50 basis point rate cut 'will undoubtedly be discussed,' 'Powell is unlikely to get enough votes.' Tara Hariharan, Managing Director of NWI Management, a global macro hedging fund, said, 'With the U.S. stock market near historical highs and potentially already reflecting the Fed's accommodative period of depth, the risk-reward tilt for further pump does not look optimistic.'
StoneX analyst Weller said that a 25 basis point rate cut could lead to a knee-jerk pump in the US dollar, and the USD/JPY could return above the key level of 142.00; a 50 basis point rate cut could potentially push the currency pair down to the psychological level of 140. Glen Capelo, Managing Director of Fixed Income at Mischler Financial Group, said that a 25 basis point rate cut by the Fed could likely result in dumping of US Treasuries, but this largely depends on Powell's press conference.
Angeles Investments Executive Partner and Chief Investment Officer Michael Rosen believes that the current bond market is pricing in a pace of Fed rate cuts that is too aggressive. The market expects the Fed to cut rates by 250 basis points next year, a magnitude that is only possible in the event of an economic downturn. Therefore, he believes that the short-term yield of US bonds will decrease less than the market expects, and the long-term yield may even start to rise from now on. Angel One analyst Saish Sandeep Sawant Dessai stated in a report, "The real risk is that the market is pricing in too dovish, which could lead to higher US Treasury yields and a stronger dollar, further weighing on gold prices."
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