25 basis points is a "huge loss", 50 basis points is "panic"! Faced with market pressure, how will the Federal Reserve cut rates tonight?

Tonight, the Federal Reserve will cut interest rates for the first time in five years. As the decision on the rate cut approaches, the suspense over the magnitude of the cut continues to escalate. The debate on Wall Street about whether it will be a "50 or 25 basis point cut" remains ongoing, and market uncertainty has suddenly increased. How will the Federal Reserve's "rate cut journey" unfold?

At 02:00 on Thursday (September 19), the Federal Reserve will announce its September interest rate decision, followed by a speech by Federal Reserve Chairman Powell at 2:30. Currently, a rate cut by the Federal Reserve is almost certain, but the magnitude of the cut remains uncertain.

Recently, whether it is inflation or non-farm payroll reports, none have decisively determined the rate cut magnitude. The market is wavering between a 50 or 25 basis point cut. During the period of silence by Federal Reserve officials, media reports suggesting a 50 basis point cut have shifted market expectations towards that camp. As of now, the market is betting heavily on a 50 basis point cut, with the probability of a 50 basis point cut rising sharply to 60%, while it is only 30% for a 25 basis point cut.

Currently, Wall Street is divided on concerns about the labor market and the Federal Reserve being "behind the curve." One side supports a 50 basis point cut, while the other side expresses concerns about ongoing inflation and the need to keep options open for future rate cuts by supporting a 25 basis point cut.

However, whether it's 25 or 50 basis points, the market is likely to experience significant volatility. The market is currently heavily betting on a 50 basis point cut, so if the Federal Reserve cuts by 25 basis points, the market will face huge losses. On the other hand, if a 50 basis point cut is implemented but subsequent actions lag behind market expectations, it could trigger panic and tighten financial conditions once again.

In addition to the magnitude of the Federal Reserve rate cut, attention should also be paid to the Federal Reserve's "dot plot" and economic forecasts, which are particularly important for this year's rate cut predictions, as well as Powell's remarks at the press conference.

The Most Controversial FOMC Meeting: 25 Basis Points "Big Loss," 50 Basis Points "Panic"

Federal Reserve decisions have always been closely watched, but the meeting content is usually somewhat predictable. However, this time, the debate over the rate cut magnitude has reached its peak.

Recent data releases have been mixed, with both inflation and employment data failing to decisively determine the rate cut magnitude. Last Wednesday's CPI data showed that inflation still has stickiness, increasing the probability of a 25 basis point cut, while last Thursday's PPI data showed a slight cooling year-on-year, slightly raising the possibility of a 50 basis point cut.

Until late last week, expectations of a 25 basis point cut were prevailing, but market sentiment suddenly shifted on Friday, bringing the possibility of a 50 basis point cut to the forefront. Market sentiment was mainly influenced by reports from "informed sources" in the Wall Street Journal and the Financial Times last Friday, and Federal Reserve officials did not explicitly refute this in subsequent market fluctuations.

Principal strategist Seema Shah stated:

For the Federal Reserve, the ultimate decision is which risk is greater: whether a 50 basis point cut will reignite inflationary pressures, or a 25 basis point cut will threaten economic recession. The Federal Reserve has been criticized for reacting too slowly to inflation crises, so it may cautiously address the risk of economic recession to avoid passive responses rather than proactive ones However, whether it's 25 or 50 basis points, the market is likely to be severely shaken. The market is currently heavily betting on a 50 basis point cut. If the Fed cuts by 25 basis points, it will be seen as "hawkish" and trigger a risk shock in the market.

Analysis indicates that now locked in a record bet with the Fed for a 50 basis point cut, if officials opt for the standard rate cut, the market will face staggering losses. 92% of economists expect this scenario to unfold. If the Fed unexpectedly takes action, the federal funds rate will be forced to be significantly repriced, and all asset classes will suffer losses.

Since last weekend, trading volume in October federal funds futures has surged to the highest level since 1988. What's more concerning is that data shows that most of these new bets are targeting a 50 basis point cut, with positions skyrocketing just this week.

And if a 50 basis point cut is chosen, such a sharp rate cut cycle would mean the economy is in distress, yet economic forecasts and corporate profit expectations remain quite optimistic. Analysis suggests that this seems to be a completely contradictory message, expecting a significant rate cut in the U.S. while also expecting profits to continue strong growth. Historically, rate cuts usually lead to reported profits falling by 20% or more, so profit expectations are expected to decline by over 30%.

Furthermore, in the absence of a clear improvement in economic conditions, subsequent rate cuts may also be slower than market expectations. If the Fed is perceived by the market to be slowing down, the Financial Conditions Index (FCI) will tighten again, leading to lower oil prices, downward inflation expectations, which could put upward pressure on real interest rates and boost a stronger dollar.

Dot plot is particularly important for this year's rate cut forecast

Equally important as the rate cut is the "dot plot." Considering that the Fed will release the latest 2025 interest rate trend "dot plot" at this meeting, the market will seek clearer guidance from the Fed on the future pace and scope of rate cuts, which will also to some extent affect market performance in September.

David Wilcox, who previously led the Fed's Research and Statistics Division and is now the Director of U.S. Economic Research at Bloomberg Economics, stated:

The dot plot at the end of the year is now particularly important, it is clearly more attention-grabbing because the Fed is on the cusp of starting a rate cut cycle.

Specifically, the dot plot will show the internal divisions within the FOMC, such as how many members support further rate cuts in November and December, especially if a large number of members lean towards further substantial 50 basis point cuts before the end of the year, this will indicate that the Fed may take more aggressive action in the future.

The release of the dot plot will directly impact market pricing of interest rates. Since the disappointing July employment report released in early August, traders have been betting on a full 100 basis point rate cut by the end of this year.

If the dot plot shows more members supporting a larger rate cut, the market may adjust asset pricing accordingly, pushing market expectations further downward

If the "dot plot" released this time shows that the median policy rate forecast returns to the level of March or lower, this would mean that the Fed's monetary policy stance is more dovish.

In addition, the Fed will also release forecasts for unemployment rate, GDP, and inflation data.

Analysts expect that the biggest adjustment in September may be related to the unemployment rate. The Fed is almost certain to raise the unemployment rate from 4.0% in June, with the current rate at 4.2%. Inflation expectations may be revised downward, with a forecast of 2.8% for full-year core inflation in June and 2.6% in July.

Goldman Sachs stated in a report that inflation appears to be lower than the FOMC's forecast in June, and the rise in the inflation rate at the beginning of the year seems more like seasonal factors rather than a reacceleration. Therefore, a key theme of this meeting will be shifting the focus to labor market risks.

What will Powell say?

In addition to adjusting the dot plot and economic forecasts, the FOMC's post-meeting statement will also be modified to reflect the expected rate cut and other forward-looking guidance from the committee.

Goldman Sachs expects that the FOMC may modify its statement to something like:

"More confident about inflation, describing inflation and employment risks as more balanced, and reiterating its commitment to maintaining full employment."

Jefferies economist Thomas Simons believes:

"I don't think they will give very specific forward guidance. At this stage of the cycle, when the Fed actually doesn't know what they're going to do, forward guidance is almost useless."