Wall Street is betting heavily on rate cuts, is the market falling into another "trap"?

Recent market fluctuations have been significant, with investors worrying about an economic recession. Rate cuts are widely seen as a remedy to stimulate the economy and boost the stock market.

However, another concern is emerging: some traders believe that overly high expectations for rate cuts may be another trap.

This is because even if the Fed cuts rates, it does not guarantee a rapid economic recovery. Moreover, if market expectations are too high, any deviation in the actual rate cut amount or timing by the Fed from expectations could lead to severe market volatility.

Diane Jaffee, Senior Portfolio Manager at TCW, said, "I don't think the Fed wants to be seen as acting recklessly. That's not what they want to do."

Rate Cut Enthusiasm Persists, Analysts: Rate Cuts Are Not a Panacea

The market has been turbulent in the past two weeks.

First, the escalation of geopolitical tensions in the Middle East, followed by the release of the July unemployment rate in the U.S., and then the decline in tech stocks dragging down the U.S. market. The Bank of Japan's rate hike triggered a liquidation of 2 trillion yen carry trades, leading to a global stock market crash, followed by a rebound in the market on Tuesday. A series of chain reactions has left the market exhausted.

This week, there were calls for the Fed to cut rates before the September rate decision. Some radical views once believed that the probability of a rate cut this week was 60%.

However, the latest U.S. initial jobless claims data released last night showed signs of improvement in the job market, easing concerns about a U.S. economic recession.

Jaffee believes that September seems to be the best time for the Fed to start cutting rates. While the possibility of a larger 50 basis point cut cannot be ruled out, a 25 basis point cut remains the baseline scenario. "They want to get things right," she pointed out.

Data shows that despite recent declines, the S&P 500 index has risen by over 12% this year.

The market has fully priced in a 25 basis point rate cut by the Fed in September. Some traders also believe that the probability of a 50 basis point rate cut in September is close to 60%, up from less than 5% a month ago. In this scenario, the federal funds rate would fall to 4.75%-5%.

Jitesh Kumar of Societe Generale believes that Wall Street may be too hasty in expecting a significant rate cut.

In a report on Thursday, he pointed out that the current changes in short-term rates indicate that investors generally expect the Fed to cut rates by over 1% in the next six months. Historically, when the market anticipates a rate cut of over 1%, it often signals an impending economic recession. In other words, the market has already priced in the possibility of an economic downturn and rate cuts in advance.**

If actual economic data does not show clear signs of a recession, and the Fed's rate cut magnitude or timing does not meet market expectations, it will lead to market volatility.

Schutte from Northwestern Mutual also believes that excessive reliance on rate cuts may lead to market neglecting other risk factors:

Rate cuts are not a panacea for all economic problems