On Thursday, the Federal Reserve will announce its first interest rate cut in four years after keeping borrowing costs at a 20-year high for more than a year.
However, what is worth noting about this meeting is that, generally speaking, despite a lot of "hype" in the market, the Fed's interest rate meetings are usually fairly predictable events. Policymakers often communicate their intentions in advance so that the market can react in advance and everyone at least has a general idea of what is going to happen. But now, the market is still uncertain about the extent of the Fed's interest rate cuts.
Forecasters generally expect the FOMC to cut interest rates by 25 basis points, bringing the federal funds rate to a range of 5% to 5.25%, but economists at JPMorgan Chase & Co. expect the Fed to take an "aggressive first step" by starting the rate cut cycle by 50 basis points, and investors also believe that a 50 basis point cut is more likely.
In addition to the rate decision, the Fed will also release updated quarterly projections, which will provide more insights into borrowing costs and the future direction of the economy.
Investors generally believe the Fed will cut interest rates more aggressively this year than the series of 25 basis point cuts economists expect. Financial markets have already priced in more than 1 percentage point of rate cuts from the Fed over the rest of the year, meaning the central bank will cut rates by 50 basis points at least once at one meeting.
Half an hour after the rate decision, Fed Chairman Jerome Powell will hold a press conference, where he may have to balance his own views, the views of the committee and the information conveyed by the so-called "dot plot". If the statements are different, it may bring huge market fluctuations.
"I'd like them to cut 50 basis points, but I doubt they'll cut 25 basis points. My hope is 50 basis points because I think rates are too high," said Mark Zandi, chief economist at Moody's Analytics. "They've achieved their mandate of full employment and inflation back to target, but that's not consistent with the current federal funds rate. So I think they need to normalize rates quickly and they have a lot of room to do that."
Debate over rate cuts intensifies
Derivatives market pricing around the size of the Fed’s rate cuts has been volatile in recent weeks.
Until last week, after the CPI data was released, traders locked in a 25 basis point rate cut. But by Friday, market sentiment suddenly shifted, and bets on a 50 basis point rate cut began to take over. As of Wednesday, federal funds futures traders were pricing in about a 63% chance of a larger rate cut.
Still, many on Wall Street continue to predict the Fed’s first steps will be more cautious.
Tom Simons, U.S. economist at Jefferies, said, "Tightening policies, while appearing to be effective, are not working exactly the way they thought, so easing policies should be viewed as equally uncertain. So if you are unsure, you should not rush."
However, Zandi said, "They should act quickly here, otherwise they risk damaging things."
The FOMC has kept its benchmark federal funds rate in a range of 5.25%-5.5% since its last rate hike in July 2023. That's the highest level in 23 years and has remained there even as the Fed's preferred inflation measure has fallen to 2.5% from 3.3% and the unemployment rate has risen to 4.2% from 3.5%.
The debate within the FOMC should be more interesting than the debate in the markets, and officials who usually vote unanimously may reveal unusual divisions at this meeting.
“My guess is they’re divided,” former Dallas Fed President Robert Kaplan said Tuesday. “There are some people around the table who feel like I do, who are a little late to the party and who want to get ahead of the curve and aren’t willing to take the time to chase the economy. And then there are others who just want to be more careful from a risk management perspective.”
“For the Fed, it comes down to deciding which risk is greater — reigniting inflationary pressures if it cuts by 50 basis points or the threat of a recession if it only cuts by 25 basis points,” said Seema Shah, chief global strategist at Principal Asset Management. “The Fed has already been criticized for being too slow to respond to the inflation crisis, so it may be cautious about being reactive rather than proactive about recession risk.”
Changes in wording
As for the policy statement, there could be a variety of changes to the language, including language about the balance of risks between employment and inflation.
The July statement said those risks “continue to become more balanced,” which Julia Coronado and Laura Rosner-Warburton of Macro Policy Outlook said was inconsistent with recent comments by Powell and Fed Governor Waller. They said the FOMC could use language similar to what Waller said on Sept. 6: “The balance of risks has shifted toward the employment side of our dual mandate.”
The committee could also choose to describe further labor market weakness as “unwelcome,” a term from the Greenspan era that Powell resurrected in a recent speech.
Economists are divided over whether and how policymakers will signal future rate cuts through their statements. Forty-four percent of economists surveyed by Bloomberg News said officials will acknowledge the possibility of further adjustments in the document, while 31% said they will be more explicit about their intention to take a series of rate cuts and provide guidance on the pace.
Goldman Sachs expects the FOMC "is likely to revise its statement to be more confident about inflation, portray the risks to inflation and employment as more balanced, and re-emphasize its commitment to maintaining maximum employment."
“Dot Plots” and Economic Forecasts
Each quarter the Fed releases its so-called Summary of Economic Projections, which includes policymakers’ individual forecasts for the federal funds rate, unemployment, economic growth and inflation. The forecasts released this week will cover the years 2024 to 2027.
The forecast is likely to include a variety of views on the path of interest rates this year. At the July FOMC meeting, some participants saw a rate cut as a reason given rising unemployment and slowing inflation. Since then, the labor market has weakened further. On the other hand, the unexpected rise in the core consumer price index excluding food and energy in August provides a reason for caution.
While the median of the “dot plot” may indicate three quarter-point rate cuts this year, there may be some officials who think the Fed should cut rates sooner.
“There are some who think it should be a 50 basis point cut this time or a 50 basis point cut later this year,” said Derek Tang, an economist at LH Meyer/Monetary Policy Analysis in New York. “The economy is slowing faster than they expected.”
Economic forecasts for this year are also being revised. The unemployment rate is above the 4% the Fed forecast in June, while the Fed’s preferred inflation measure (2.5%) is below the committee’s most recent median forecast.
What will Powell, the “King of Damage”, say?
In addition to the above points, Powell's press conference will be worth watching, when investors will get a glimpse into the thinking of a Fed chairman who, Fed watchers judged, is more troubled by recent labor market weakness than the median voter on the committee.
Powell is increasingly confident that the Fed can curb inflation with little damage to the economy and jobs. Rising unemployment now would come with huge political and economic costs that any central banker would want to avoid.
If officials ultimately decide to cut rates by a quarter point, Powell would be able to signal that he aims to prevent further deterioration in the labor market. “Powell’s message will be: We wish we had additional ammunition on hand, but we’re not going to use it today,” said Ellen Meade, a research professor at Duke University and a former senior adviser for policy and communications at the Fed’s board of governors.
“I don’t think they’re going to be particularly specific about any type of forward guidance,” Jefferies’ Simon said. “Forward guidance at this stage in the cycle is of little use when the Fed doesn’t actually know what they’re going to do.”
It is worth noting that if Powell signals, as expected, that the fight against inflation is about to end and cuts interest rates, he will come under fierce partisan attack this week.
Gold may not get a boost tonight? Hold on to this point and the future will still be "bright and promising"
Currently, gold has already responded to the Fed's expectations of a sharp rate cut and has repeatedly hit record highs. Many major banks have also raised their target prices for gold, with $2,700, $2,800 and even $2,900 for next year.
Some analysts pointed out that if the Fed cuts interest rates by 25 basis points or 50 basis points in September, the boost to gold prices may be relatively limited. The trend of gold prices after the first rate cut needs to observe the fundamentals of the US economy and the subsequent policy responses taken by the Fed. If the economy achieves a "soft landing" as expected after the rate cut, it may be unfavorable for the continued upward trend of gold prices; on the contrary, if the rate cut fails to prevent the economy from a "hard landing", the Fed may increase the intensity of rate cuts to boost market confidence, and the upward trend of gold prices will be supported.
Goldman Sachs predicts that if the Fed chooses to cut interest rates by 25 points this week, gold may face a small correction in the short term, but then it will hit a new record high driven by the inflow of funds into gold ETFs. Goldman Sachs analysts Lina Thomas and Daan Struyven pointed out in the report that "the Fed's interest rate cut will drive Western funds to flow back into gold ETFs, a factor that has been largely absent in the surge in gold prices over the past two years."
They reiterated Goldman Sachs' forecast that gold prices will rise to $2,700 an ounce early next year. Goldman Sachs economists expect the Federal Reserve to cut interest rates by 25 basis points on Wednesday. Under this basic forecast scenario, gold prices may see some tactical declines, but it is expected that as the Federal Reserve starts an easing cycle, gold ETFs will attract gradual inflows, thereby driving up gold prices.
On the technical side, FXStreet analysts pointed out that gold buyers have regained control, and the 14-day relative strength index (RSI) has fallen back from near the overbought area, still comfortably above the 50 level. As long as the bulls hold the symmetrical triangle target of $2,560 a month and a half ago, optimism will prevail. The current direct resistance for the bulls is at the historical high of $2,590. If it breaks through here, the next resistance will be the round mark of $2,600, followed by the psychological mark of $2,650.
If the Fed disappoints the doves, gold prices could see a new round of selling and could test the August 20 high of $2,532. If it loses here, gold could fall further to $2,522, the 21-day simple moving average, and then the psychological level of $2,500.
The article is forwarded from: Jinshi Data