As the next Federal Open Market Committee (FOMC) meeting approaches, speculation is intensifying over the Federal Reserve’s next move.
With the economy sending mixed signals, investors are eagerly anticipating a rate cut at the upcoming Federal Reserve meeting.
But the question on everyone’s mind is: Will a 50 basis point (bps) cut actually save the economy, or could it signal something more worrying?
A troubled labour market
Recent data from the US labour market has been anything but reassuring. The August jobs report, which many had hoped would signal a stable employment landscape, fell short of expectations.
Nonfarm payrolls grew by just 160,000 jobs, a modest increase compared to the 114,000 added in July. Meanwhile, the unemployment rate, which had been hovering near a three-year high, ticked down slightly to 4.2% from 4.3%.
Yet beneath these headline numbers lies a more troubling narrative. The number of job openings has dropped to its lowest level since 2021, according to the Job Openings and Labour Turnover Survey (JOLTS).
This decline, coupled with the Federal Reserve’s Beige Book report, paints a picture of an economy where hiring is slowing, citing concerns about demand and an uncertain economic outlook.
The labour market’s recent struggles have led to speculation that the Federal Reserve may opt for a more aggressive rate cut at its September meeting.
While a quarter-percentage-point cut had been widely expected, the possibility of a 50bps reduction is now on the table, with the market pricing a 45% chance for a 50bps cut and 55% chance for a 25bps cut.
This shift in expectations reflects growing concerns that the economy may be weakening faster than anticipated.
The case for a 50bps rate cut
A 50bps rate cut, while larger than usual, could be seen as a necessary step to prevent a more significant downturn.
Lowering interest rates would reduce borrowing costs for businesses and consumers, potentially boosting investment and spending. This, in turn, could help stabilize the labour market and prevent further job losses.
Moreover, with inflation appearing to moderate, the Federal Reserve has more room to manoeuvre.
The Beige Book noted that “prices and wages increased modestly” in recent weeks, suggesting that the central bank’s battle against inflation is yielding results.
With inflationary pressures easing, the Fed can afford to shift its focus to supporting growth and employment.
Perhaps the market has been slow to recognize the extent of labor market weakness. Ultimately, the unemployment rate has been inching up for months, signaling that the labor market is weakening.
In this context, a 50bps cut might not only be justified but necessary to prevent the economy from slipping into a recession.
By acting decisively, the Fed could help restore confidence and encourage businesses to maintain or even expand their workforces.
The risks of going big
However, a larger rate cut also carries significant risks. Critics argue that such a move could send the wrong message to markets, signaling that the Federal Reserve is more concerned about a potential recession than about managing inflation.
This could undermine confidence and lead to increased volatility in financial markets.
David Sekera, Morningstar’s chief U.S. market strategist, warns that a 50bps cut “would be like the pilot hitting the oxygen masks deployment button—not exactly the recipe for a ‘soft landing.’”
In other words, a more aggressive rate cut could inadvertently trigger panic rather than provide reassurance.
Moreover, while lower interest rates can stimulate demand, they may not be enough to address the underlying issues in the labour market.
The Beige Book highlighted that some firms are already reducing shifts and hours, leaving positions unfilled, or cutting headcounts through attrition.
These trends suggest that businesses are not merely reacting to interest rates but are also concerned about broader economic uncertainties.
A larger rate cut could also have longer-term consequences for the US economy. With interest rates already near historic lows, the Federal Reserve has limited ammunition left to respond to future crises.
By opting for a 50bps cut now, the central bank risks exhausting its policy tools prematurely, leaving it with fewer options if the economy continues to deteriorate.
Be careful what you wish for
So, should investors be cheering for a larger rate cut? The answer isn’t straightforward. While a 50bps cut could inject some short-term optimism into the markets, it also carries the risk of signaling deeper economic issues.
Therefore, investors should not rush to celebrate any easing move by the Fed. A sudden, significant rate cut might be more of a red flag than a green light.
Given these considerations, many economists believe that the Federal Reserve is more likely to opt for a quarter-percentage-point cut at its upcoming meeting.
This more measured approach would still provide some stimulus to the economy while avoiding the potential pitfalls of a larger cut.
A 25bps reduction would signal that the Fed is attentive to the risks facing the economy without overreacting to the latest data.
It would also leave the central bank with room to manoeuvre in the coming months, should further cuts be necessary.
In the end, the Fed’s decision will hinge on its assessment of the economy’s underlying health. Whether a larger rate cut will save the economy or signal deeper troubles remains to be seen.
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