Whether it’s one rate cut or more, Fed’s Powell likely to act with caution as inflation stays high
US central bank expected to cut rates by 25 basis points to a range of between 4% and 4.25 % this week
A US Federal Reserve rate cut this week is already priced into US stocks, and the big question now is whether it will be the last.
Famously, the stock market perceives any rate cut by the US central bank like a punchbowl at a party. A cut excites the risk-taking, party mood on the stock market by making it cheaper to borrow money. Investors can use the cheap credit to buy stocks “on margin”, and corporations can splash out on buying other corporations. Inflation follows these excesses as inevitably as a hangover follows the consumption of the punch.
Fed chairman Jerome Powell has warned repeatedly that this is no time for any recklessness, especially with inflation already on the rise. That’s why many Wall Street economists expect him to put a strict limit on the rate cut this time around.
Powell may not explicitly make the Fed’s decision – due on Wednesday (Sep 17) at the end of its two-day policy meeting – a one-off, but most Wall Street firms expect him to continue warning about inflation risks. Few strategists anticipate more than three rate cuts in the foreseeable future.
The Fed will most likely cut rates by a quarter-of-a-percentage point to a range of between 4 per cent and 4.25 per cent, and vow to remain attuned to the data before the October meeting.
Following a sharp revision to estimated jobs growth in the 12 months up to March and a four-year high in new weekly jobless claims, the Fed could “go back to the question of 25 (basis points) versus 50”, said JD Joyce, the president of Texas-based financial advisory Joyce Wealth Management.
A 50-basis-point cut is highly unlikely, and would surely stoke huge moves in stocks if the Fed went through with it. There could be a huge rally because of the unexpectedly large dose of punch, or a huge sell-off because of the Fed’s apparent sense of urgency, or both.
Even more influential than the size of the cut will be how Powell frames the Fed’s future plans. He should provide a strong indication in his customary press conference following the statement as to what he intends to do next.
“Powell’s characterisation of the labour slowdown (cyclical or structural?) and inflation (one-off or sticky?) should provide clues on his expected policy path,” said strategists at Bank of America Global Research in a note that cheekily asked whether the Fed’s move would be viewed in history as “policy adjustment or capitulation”.
There’s good reason to expect Powell to talk down the likelihood of an extended rate-cutting cycle. After all, consumer inflation heated up in August, albeit not by as much as Wall Street economists had predicted. At 2.9 per cent, it’s still far from the Fed’s 2 per cent target and likely to move further from that target following the initial rate cut.
Economists say US corporations have been slow to raise prices due to concerns about weakening demand. As things stand, the full impact of the dramatic increase in US tariffs may not have registered on consumer prices yet.
Other strategists argue that Powell is anticipating the downward pressure from labour markets will more than offset the upward pressure on prices from the rate cut.
“The August employment report should keep the Fed concerned about downside risk in the US labour market and reinforce a ‘look through’ mentality on inflation,” said strategists at Morgan Stanley.
Many analysts are divided on what the stock market’s reaction to the Fed’s actions will be. Some Wall Street trading desks are reportedly betting that the rate cut is so widely anticipated that it will be a “buy the rumour”.
The US stock market is likely to resume global leadership after a period of underperformance due to the weaker US dollar, a resilient economy and the “broadening” of the artificial intelligence (AI) boom, said Tang Yuxuan, a global market strategist at JP Morgan Private Bank.
Cheap credit, after all, has helped to drive AI infrastructure investment.
Blackstone – now vying with Goldman Sachs and Morgan Stanley as the largest publicly traded firm on Wall Street – is among the firms making massive loans to real estate developers for the countless data centres needed to house the supercomputers feeding voracious AI chatbots.
The Fed’s next move on interest rates – and hence the fourth-quarter stock-market performance – will likely be decided by US jobs data in the coming weeks, according to another research note from strategists at Bank of America Global Research. Expectations of more rate cuts could either be confirmed or undermined by this data, they said.
At Citi’s wealth management unit, strategists are warning clients that the sleepy stock market of the last couple of months was likely the calm before an upcoming storm, as traders adjust to the “fluid” rate outlook and a slowing US economy.
Rate cuts aside, all eyes will also be on whether the Fed chief will address another potentially market-moving issue during his press conference: the Fed’s independence.
While US President Donald Trump has backed off attempts to oust Powell himself, Trump is also trying to fire Fed governor Lisa Cook. A court has temporarily blocked this effort while the judge considers whether Trump’s allegations of mortgage fraud meets the statutory requirement that Cook be fired “for cause”. Here, too, Powell will have to walk a fine line.
