"New Federal Reserve News Agency" reiterates uncertainty: the magnitude of the first rate cut remains uncertain

As the Federal Reserve is about to start its first rate cut in over four years, the market is uncertain about the extent of the rate cut. Well-known financial journalist Nick Timiraos, also known as the "New Fed News Agency," is one of the main culprits behind this situation. He previously described a rate cut of 25 basis points or 50 basis points as a "close call." On Tuesday, he once again wrote that the size of the Fed's first rate cut is questionable. The following is an excerpt from the full text.

The decision to lower the Fed's benchmark interest rate (currently at a two-decade high of 5.25% to 5.5%) by either 50 basis points or the traditional 25 basis points will depend on how Fed Chairman Powell leads his colleagues through a series of careful considerations.

Former Fed senior advisor William English stated, "For them, the key issue at this meeting is their perception of risk balance. If they are more concerned about growth and employment than inflation right now, they are likely to want to take some insurance measures, namely a 50 basis point rate cut. The rationale for a 25 basis point cut is based on different considerations, including strong economic fundamentals, or the risk of reigniting inflation if rates are cut too quickly."

English said a few weeks ago that a smaller rate cut would be appropriate. But the recent downward trend in employment data has made him more nervous, especially because even after two to three rate cuts, rates will still be at relatively high levels.

Fed officials typically prefer to raise or lower rates in 25 basis point increments to study the effects of these measures. However, they act more quickly when they believe their rate stance is not well aligned with risk balance. For example, in 2022, the Fed raised rates in increments of 50 and 75 basis points to combat high inflation.

Shift in Rate Cut Expectations

Until late last week, investors expected the Fed to cut rates by only 25 basis points this week, as few officials publicly called for a larger rate cut. "Their communication suggests a 25 basis point rate cut. And the data performance is also decent," said former Fed Governor Laurence Meyer.

Esther George, who served as President of the Kansas City Federal Reserve Bank from 2011 to 2023, said, "Because inflation is still above the Fed's target and the economy is 'overall in good shape, you can start with a 25 basis point rate cut and then say, 'We either maintain this rate cut pace for a while, or if the situation looks weaker, we can intensify.'"

Fed officials did not commit to a rate cut size on the eve of the pre-meeting blackout period that began on September 7. Fed Governor Waller stated on September 6 after the latest jobs report was released, "When inflation accelerated in 2022, I strongly advocated for an early rate hike, and if appropriate, I would also advocate for an early rate cut." In the following Q&A session, he sounded relatively calm about the recent slowdown in job growth. He said, even if monthly job growth drops to 100,000, "it's okay," "there's nothing to be afraid of."

New York Fed President Williams, in a speech on the same day, said recent data indicates "a fairly common trend... what we are seeing is a continued cooling signal. We hope the economy remains balanced."

Is a 50 basis point rate cut "regrettable"?

Federal Reserve officials often refer to their work as risk management, such as balancing the risks of inflation heating up with the risks of accelerating unemployment. They typically use interest rates to manage risks that appear to be more costly. For much of the past 2.5 years, as the inflation rate soared to over 7%, risk management tended towards more aggressive rate hikes to prevent inflation from becoming entrenched.

Robert Kaplan, who served as Dallas Fed President from 2015 to 2021, said that if officials consider which choice they are less likely to regret at this week's meeting, it makes sense to start a easing cycle with a 50 basis point rate cut.

"If I were still in my old job, I would say, 'I can accept a 25 basis point rate cut, but I support a 50 basis point cut,'" said Kaplan, current Vice Chairman of Goldman Sachs. He said, given inflation and the unemployment rate, the Fed's benchmark interest rate should be about 100 basis points lower than it is now.

Kaplan said that as inflation has not been completely defeated, the Fed should avoid further weakening of the economy, which would force the Fed to cut rates faster or more aggressively to avoid reigniting inflation.

He said that if economic conditions deteriorate between now and the next meeting in early November, Fed officials are less likely to regret a larger rate cut this week, as rates will still be at relatively high levels. However, if the Fed takes smaller actions and the labor market deteriorates more quickly, officials will feel more regretful.

Minutes from the Fed's late July meeting showed that some officials supported a rate cut at that time, but most preferred to wait. And the July hiring data released two days after the Fed's July meeting was far below expectations.

"The Fed is already behind by one meeting, they have a chance to catch up. But if they could do it over, I would have preferred a rate cut in July," Kaplan said. "I'd rather correct this now, take the lead, than fall behind the curve all fall, chasing economic downturn."

Where is the road ahead?

As important as the Fed's rate cut decision this week is its quarterly economic forecasts, which show officials' expectations for year-end interest rates. While not the result of committee deliberations, these forecasts are typically just as important to financial markets, as policymakers' rate outlooks can affect a range of borrowing costs for mortgages, car loans, and corporate debt.

The updated forecasts at the September meeting are particularly informative, as the Fed only has two meetings left this year in November and December, **the new forecasts will provide unusually specific guidance for these meetings' decisions If more officials are expected to cut interest rates by a total of 100 basis points this year, it would mean there will be at least one 50 basis points cut this year. Delaying a larger rate cut to later in the year could raise awkward questions about why this is the best approach. Another option is to cut rates by 25 basis points now, and anticipate similar moves at the last two meetings of the year, while retaining the option to accelerate rate cuts if the economy deteriorates.

With this week's decision on a knife-edge, Powell may face at least one dissenter among the 12 policymakers, including 5 regional Fed presidents and 7 Fed governors who vote on policy. No Fed official has dissented on a policy decision in the past two years, the longest stretch in half a century. Additionally, no Fed governor has dissented on a rate decision since 2005.

Ingrid said the Fed's rate decision this week is at a critical juncture, reflecting officials' uncertainty about the choice. "It's not that you have half the committee supporting a 50 basis points cut and half supporting a 25 basis points cut, yelling at each other. It's that these people really aren't sure what's right to do here," she said. "In the end, Powell may build a reasonable consensus around one side."