Hawkish vs. Dovish! How much will the Fed cut in September?

The Federal Reserve is facing a difficult decision: next week, will it make a significant 50 basis point rate cut, or opt for a more gradual 25 basis point cut?

As the futures market increasingly leans towards the Fed taking a more moderate 25 basis point rate cut after its key meeting next Thursday, questions arise about the magnitude of the rate cut.

Any rate cut next week will be the first in over four years by the Federal Reserve, and it comes after maintaining rates at a 23-year high of 5.25% to 5.5% (since July last year), with 7 weeks to go until the November U.S. presidential election.

Federal Reserve officials unanimously support taking rate-cutting measures, as there are signs of slowing inflation, and they are focused on preventing excessive economic damage from keeping borrowing costs above necessary levels. How to quickly return to a "neutral" level that does not suppress economic growth is the next question they must answer.

However, a 50 basis point rate cut by the Federal Reserve in September would allow the Fed to more quickly restore borrowing costs to normal levels, eliminate its drag on the economy, and protect the labor market from further weakening. Krishna Guha, Vice Chairman of Evercore ISI, stated that a 50 basis point rate cut by the Fed next week "will reduce the risk of a soft landing."

Former Federal Reserve Vice Chairman Donald Kohn stated that even if the Fed chooses to slow down next week, it can quickly adjust its policy, as it did in 2022 when inflation proved more stubborn than expected. "If they wait too long, they do have an opportunity to make up for it through the speed of the rate cut and their signals about future rate cuts," he said.

Policymakers have not issued warnings about the outlook for the U.S. economy, but have cautioned about rising downside risks. Meeting minutes show that some believe a rate cut at the recent meeting was "appropriate." Since then, employment and inflation data have become more favorable for rate cuts.

Federal Reserve Chairman Powell stated last month that the Fed will "do everything we can to support a strong labor market while making further progress towards price stability."

Federal Reserve Governor Waller stated last Friday that he is "open to the magnitude and pace of rate cuts," and he would support larger rate cuts if data indicate the need. However, he noted that any action is expected to be taken "cautiously."

Also last Friday, New York Fed President Williams stated that he has not decided on the magnitude of the rate cut this month, but he said the Fed is "well prepared" to achieve its inflation and employment goals. When asked about the magnitude of the first rate cut, he told reporters, "We will gather together, analyze all the content, and discuss this issue."

However, a more aggressive 50 basis point rate cut by the Federal Reserve this month also carries risks.

Recent data has been mixed, with the latest employment report showing a slowdown in monthly growth but a decrease in the unemployment rate, along with rising wages. This week's inflation data shows that price pressures are easing, with the core consumer price index inflation stabilizing even when volatile food and energy prices are excluded A 50 basis point rate cut may also raise concerns about the Fed's increasing worries about the economic outlook. It may also prompt financial markets to price in larger rate cuts beyond the Fed's planned easing pace.

Retired Cleveland Fed President Mester, who retired in June, said, "The Fed can defend a 50 basis point rate cut, but the communication around this is complex, and there is no convincing reason to take on this challenge."

Former Fed Vice Chairman and current Pimco executive Clarida said, "A 50 basis point rate cut does not necessarily guarantee a positive reception or boost confidence 100%, which could lead the market to think, 'Wow! Does the Fed know something we don't?'"

Considering that Republican presidential candidate Trump previously warned the Fed not to cut rates in September, a larger-than-expected rate cut would also expose the Fed to political risks.

Powell recently stated that the Fed "will never use our tools to support or oppose any party, politician, or political outcome."

Futures markets indicate that the Fed will cut rates by 1 percentage point by the end of the year, meaning that in the remaining three meetings, the Fed will cut rates by at least 50 basis points in one meeting