Chief Economist of Morgan Stanley: The Federal Reserve must take major action in September

JP Morgan's Chief Economist Michael Feroli believes that the Fed should cut rates by 50 basis points at the September meeting.

The chief US economist made the comments on Thursday during an interview with CNBC's Squawk on the Street, stating, "We think they should get back to neutral rates as soon as possible, and there's a good reason for that." He added that the Fed's neutral policy rate peak is around 4%, which is 150 basis points lower than the current level. "We think they have good reason to accelerate the pace of rate cuts."

According to the data from the CME Fed Watch Tool, traders expect the Fed to cut the federal funds rate target range from the current 5.25%-5.50% by 50 basis points to 4.75%-5%, with a 39% probability. The probability of a 25 basis point cut to a range of 5% to 5.25% is about 61%.

"If you wait for the inflation rate to return to 2%, you may have waited too long," Feroli also said. "Although inflation is still slightly above target, the unemployment rate may be slightly higher than they think is consistent with full employment. Right now, there are risks to both employment and inflation, and if one of those risks is materializing, you can always reverse course."

His comments come as August saw the weakest private sector job growth since January 2021. Prior to this, the unemployment rate in July rose slightly to 4.3%, triggering the so-called "Sam Rule" economic recession indicator.

Nevertheless, Feroli said he does not believe the economy is "collapsing." The economist continued, "If the economy were collapsing, I think at the next Federal Open Market Committee (FOMC) meeting, the Fed would have reason to cut rates by more than 50 basis points." The Fed will make a decision on interest rates on September 17th and 18th.

Traders still expect the Fed to cut rates by over 100 basis points this year, which could mean a significant rate cut. Given Powell's recent emphasis on the labor market, many believe that the employment report will determine whether the Fed cuts rates by 25 basis points or 50 basis points this month.

Tonight's non-farm payroll report is expected to show an increase of around 165,000 jobs. While higher than July's 114,000, the average increase over the past three months will slow to slightly above 150,000, the lowest level since early 2021. Following the report, New York Fed President Williams and Fed Governor Waller will make comments.

"The real danger of 'bad news' is that even if the Fed is prepared to respond actively, it may be too late to avoid real economic weakness," said Steve Sosnick of Interactive Brokers. "But some are concerned that if the news is 'too good,' the Fed may not cut rates as quickly as the market expects." Bret Kenwell from eToro stated that following the disappointing job report released last month, it's no wonder investors felt "uneasy" ahead of Friday's data release. "While the probability of the Fed cutting rates by 25 basis points at the September meeting is high, a disappointing job report could lead the Fed to cut rates by 50 basis points," he said. "If the Fed is forced to cut rates by 50 basis points directly, it may indicate that concerns about the job market are greater than previously acknowledged."

Kenwell mentioned that ideally, we should see a report on Friday that is "better than expected," showing a slowdown in the labor market but not weakness, allowing the Fed to implement a series of 25 basis point rate cuts.

Andrew Brenner from NatAlliance Securities believes that if non-farm payrolls perform strongly, the stock market should initially perform better, but if interest rates "fall significantly," it would not be good. Conversely, if interest rates rise due to weak economic data, it would also be unfavorable for the stock market. He concluded, "So we are in a lose-lose situation."

A survey conducted by 22V Research showed that the majority of investors (44%) believe the market's reaction to Friday's data will be "risk-on," 27% think it will be "risk-off," and 29% believe it will be "negligible or mixed." This survey also highlighted a significant shift - unemployment rate received more attention this month. Meanwhile, attention to wage growth further declined. 52% of respondents expect the addition of new jobs to exceed the expected 165,000.

Stan Shipley from Evercore believes that the ADP private sector employment data released on Thursday and other labor market indicators show that the employment data for August was "weak." Jeffrey Roach from LPL Financial stated, "Considering the slowdown in ADP, tomorrow's job report may be weaker than expected. If the job report surprises investors and is weaker than expected, the likelihood of a 50 basis point rate cut at the upcoming Fed meeting will increase." Although ADP reports have not been good at predicting non-farm payrolls in recent years, their relevance has been improving this year