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The debate about just how deep the Federal Reserve will cut interest rates continues to heat up. And in a late-breaking swing, team 50 basis points is leading over team 25.
There’s been a prevailing thought over the past month, which we’ve noted before, that if the central bank does opt for the larger of the two interest rate cut scenarios, it could prompt panic in markets.
It may be a good sentiment to consider, but markets are all about expectations. Panic usually comes when something unexpected happens, and the Fed — even as it keeps a healthy distance from the daily swings of the stock market — is more likely to play within the lines.
“I think the Fed would be reluctant to surprise the market,” Deutsche Bank chief US economist Matthew Luzzetti told Yahoo Finance.
As of Monday, that bigger cut would now be anything but unexpected: Markets were pricing in a 61% chance the Fed opts for a 50 basis point interest cut on Wednesday, per the CME FedWatch tool. With odds like that, it’s hard to argue that’s going to spring outright panic.
From Monday’s view, in fact, you can even argue that the Fed would actually be tightening policy by opting for a 25 basis point cut, given how things are priced in.
“Unless something changes, going 25 will tighten financial market conditions, pushing interest rates up,” Renaissance Macro’s head of economics Neil Dutta wrote in a note to clients on Monday morning. “Monetary policy works through the financial markets. Tighter financial conditions should be avoided when the balance of risks between growth and inflation have shifted as they have now. If the downside risks to employment outweigh the upside risks to inflation, then the Fed should be leaning against tightening financial conditions, all else equal.”
EY chief economist Gregory Daco offered a similar opinion on Yahoo Finance’s show Catalysts on Monday morning.
“People are saying, well, 25 basis points doesn’t really matter,” Daco told Yahoo Finance, pointing to the small numeric differences we’d see on the Street with interest rates.
“But,” he continued, “the risks are asymmetric. If the Fed does not ease monetary policy by as much as markets are anticipating, then you’ll actually see a repricing of rates and you’re going to see upward movement in terms of rates.”
Movement that damages consumer spending, sentiment, and potentially the economy, per Daco.
In a note to clients on Friday, Goldman Sachs chief US equity strategist David Kostin wrote that his team sees the S&P 500 hitting 6,000 in the next 12 months, with the make-or-break of that target all about whether the Fed’s moves can keep the current economic growth story intact.
“While some investors believe the speed of Fed cuts will be the key determinant of equity returns in coming months, the trajectory of growth is ultimately the most important driver for stocks,” Kostin wrote.
So if the Fed needs to cut by 50 basis points to make sure its policy isn’t so restrictive that it crushes the current market expectations for continued economic growth as the US avoids recession and achieves a soft landing, then so be it. It’s already expected at this point, anyway.
Josh Schafer is a reporter for Yahoo Finance. Follow him on X @_joshschafer.
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