Preview of the Federal Reserve interest rate decision: Besides the initial rate cut, what other important information is worth paying attention to?

In the past, although the market would constantly speculate on the Federal Reserve's interest rate meetings, it was usually predictable. Policymakers would convey their intentions in advance, the market would respond, and every investor would have a rough understanding of what was about to happen.

But this time seems different.

This week's Federal Open Market Committee (FOMC) meeting of the Federal Reserve was filled with an unusually mysterious atmosphere. Despite the collective market consensus that the Fed will cut interest rates, there is still fierce debate about how much the policymakers will cut rates by.

Will it be a traditional 25 basis points cut, or will they take a more aggressive first step with a 50 basis points cut?

Observers of the Federal Reserve are uncertain about this, which may make this FOMC meeting more influential than before. The Fed's interest rate decision will be announced at 2 a.m. Beijing time on Thursday.

"I hope they cut by 50 basis points, but I doubt they will. I hope it's 50 because I think rates are too high," said Mark Zandi, chief economist at Moody's Analytics. "They have achieved full employment and inflation back to target, which is inconsistent with a target federal funds rate of around 5.5%. So, I think they need to normalize rates quickly, and there is plenty of room to do so."

The pricing in the derivatives market surrounding the actions the Fed will take has been unstable.

Until late last week, traders had been locked in on a 25 basis points rate cut. But by Friday, market sentiment suddenly changed, bringing the 50 basis points cut back into discussion. As of the time of writing, the market expects a 35% probability of a 25 basis points rate cut at this week's meeting, and a 65% probability of a 50 basis points rate cut.

Many Wall Street professionals continue to predict that the Fed's first step will be more cautious.

"Although the tightening policy seems to have worked, the effects are not entirely as they expected, so the easing policy should also be seen as having an equal amount of uncertainty," said Tom Simons, U.S. economist at Jefferies. "So, if you're unsure, you shouldn't rush."

Zandi from Moody's Analytics expressed a more dovish view: "They should act quickly, otherwise, they could make a mistake."

It is expected that there will also be disagreements within the FOMC.

Former Dallas Fed President Kaplan said on Tuesday, "I guess they are divided. Some of the people in the room will feel the same way as me, thinking their actions are a bit late, they want to step forward, and they don't want to spend the fall chasing the economy. From a risk management perspective, there are also some who just want to be more cautious."

Other Focus

In the view of analysts, in addition to the debate over 25 or 50 basis points, this meeting is expected to have other information worth paying attention to.

Proceed with caution

Since the last rate hike in July 2023, the FOMC has kept the benchmark federal funds rate between 5.25% and 5.5%.

This is the highest level in 23 years, despite the Fed's preferred inflation gauge dropping from 3.3% to 2.5% during this period, and the unemployment rate rising from 3.5% to 4.2%, the rate has remained at this level.

In recent weeks, Fed Chair Powell and other policymakers have made it clear that this meeting will involve a rate cut. The decision on the magnitude of the rate hike will need to balance the fight against inflation with concerns about the significant slowdown in the labor market over the past few months.

Seema Shah, Chief Global Strategist at Principal Asset Management, said: "For the Fed, the key is deciding which risk is greater - a 50 basis point rate cut would reignite inflationary pressures, while a 25 basis point cut could potentially trigger a recession. Criticized for reacting too slowly to the inflation crisis, the Fed may take a passive response to the risk of an economic downturn rather than a proactive stance."

"Dot Plot"

Perhaps equally important as the rate cut will be the signals participants send about their expectations for future rate movements.

This will be achieved through the "dot plot," where each official will indicate their views on the future direction of rates in a grid. This week's Summary of Economic Projections (SEP) will include forecasts for 2024 to 2027.

In June this year, FOMC members only expected one rate cut before the end of the year. This is almost certain to accelerate as, with only three meetings left, market pricing reflects up to five 25 basis point rate cuts, or a total cut of 125 basis points.

According to CME's Fed watch tool, traders expect the Fed to significantly lower rates next year, cutting the current overnight repo rate by 250 basis points before stopping the rate cuts.

Zandi said about the market outlook: "This feels too aggressive unless you know the economy is about to weaken significantly." Moody's expects the remaining three meetings of this year (including this week's meeting) to cut interest rates by 25 basis points.

Economic Forecast

The dot plot is part of the FOMC's Summary of Economic Projections (SEP), which also provides unofficial forecasts for unemployment rate, Gross Domestic Product (GDP), and inflation.

The most likely adjustment to the SEP is the unemployment rate, with the committee almost certain to raise the unemployment rate from the 4.0% forecasted in June. The current unemployment rate is 4.2%.

The core inflation rate forecasted for the whole year in June's SEP was 2.8%, a number that may also be revised downward as July's core inflation rate stands at 2.6%.

Goldman Sachs economists stated in a report: "Inflation appears likely to be lower than the FOMC's forecast in June, with the high inflation at the beginning of the year increasingly looking like residual seasonal effects rather than a reacceleration. Therefore, a key theme of the meeting will be shifting focus to labor market risks."

FOMC Statement

In addition to adjustments to the dot plot and SEP, the committee's post-meeting statement must also be revised to reflect the expected rate cut and any additional forward guidance the committee will provide.

The statement and SEP released at 2 a.m. Beijing time on Thursday will be the first market reactions, followed by Powell's press conference at 2:30.

The wording of the statement may undergo several changes, including around the balance of risks between employment and inflation.

The July statement mentioned that these risks "continue to tilt toward better balance," a statement that is now inconsistent with recent remarks by Powell and Fed Governor Waller, according to MacroPolicy Perspectives' Julia Coronado and Laura Rosner-Warburton. Coronado and Rosner-Warburton suggested that the FOMC could adopt a similar language to what Waller said on September 6: "The balance of risks has shifted toward the employment side of our dual mandate."

Goldman Sachs expects the FOMC to "likely modify its statement to express more confidence in inflation, describe inflation and employment risks as more balanced, and reiterate its commitment to maximizing employment."

The committee may also choose to describe further weakness in the labor market as "unwelcome," a term from the Greenspan era that Powell recently used in a speech.

Economists are divided on whether and how policymakers will signal future rate cuts in the statement. About 44% of economists surveyed said officials will acknowledge the possibility of further adjustments in the document, while 31% said they will more explicitly indicate the intention to seek a series of rate cuts and provide guidance on the pace of cuts.

Jefferies economist Simons said: "I don't think they will be particularly specific about any form of forward guidance. At this stage of the economic cycle, forward guidance is not very useful because the Fed doesn't actually know what it wants to do."Powell Press Conference

The subsequent press conference will not only allow people to understand the committee's thoughts, but also Powell's views. Observers of the Federal Reserve believe that Powell's concerns about the recent softening of the labor market are more unsettling than the committee's general view.

Powell is increasingly convinced that the Federal Reserve can contain inflation without affecting the economy and employment. A surge in the unemployment rate will bring high political and economic costs, something that any central bank governor would want to avoid.

Anna Wong, Chief Economist for Bloomberg Economics in the United States, said, "The Federal Reserve is almost certain to start a rate-cutting cycle at the meeting on September 17-18. Whether they start with a 25 basis point cut or a 50 basis point cut is still unknown. In our view, the consistency of forecasts and risk management suggest that 50 basis points is the right choice. So far, there is a lack of clear guidance on the possibility of a significant rate cut, indicating a preference for a 25 basis point cut."

If officials do choose to cut rates by 25 basis points, Powell can freely state that his goal is to prevent further deterioration in the labor market.

"The message conveyed will be: we want to keep more ammunition, but we won't use it today," said Ellen Meade, former senior advisor for Federal Reserve policy and communication and current research professor at Duke University