All Eyes on the FOMC

It’s always tempting to think that the next upcoming market event is among the most consequential ever.  We will try to resist the hyperbole ahead of tomorrow’s FOMC announcement, but it is fair to say that there is quite a bit riding upon its outcome.  The Federal Reserve last cut rates in December, and stock markets had quite a ride in the ensuing nine months.  With another cut tomorrow seeming certain, the questions are more about what might come next.  On that front, there is plenty of room for debate.

As I write this late Tuesday morning, CME Futures show a 96.1% probability of a 25 basis point cut, with the additional 3.9% favoring a 50 bp cut tomorrow.  The expectations for a larger cut peaked a week ago Friday at about 11% after the August jobs report and have been creeping lower in the ensuing days.  Participants on IBKR ForecastTrader agree, with a 95% “Yes” for a 25bp cut and a 6% “Yes” for a 50bp cut.  The consensus seems pretty well baked in, and we have come to expect that the Fed has no interest in upsetting market consensus without a darn good reason for doing so.  Political considerations aside, there does not appear to be a solid economic justification for either a larger move or a shocking “no action”.

Labor has clearly been stagnant at best, but a 4.3% Unemployment Rate is historically quite enviable. A cut could indeed spur some hiring, but it does not appear that the situation is dire enough to warrant aggressive measures.  Meanwhile, considering the subtle but steady inflation pressures in recent reports – we have noted that Core PCE and Core CPI have been inching higher for each of the past four months – a larger cut could create concerns about laxity toward the Fed’s “stable prices” goal.  We’ve frequently referred to Chair Powell as “Goldilocks in a Suit”, and 25 bp at this moment seems “just right”.

The questions will then arise regarding the future path of rates.  The FOMC will be releasing its Summary of Economic Projections, aka the SEP or “Dot Plot”.  The last release, in June, showed median projections of 3.875% for rates at the end of 2025 and 3.625% at the end of 2026.  Those are well above the market’s expectations of 3.625% for the end of this year and 2.875% for the end of 2026.  The latter figure likely reflects expectations that the next Fed Chair will hew more towards the President’s goal of sharply lower rates, but the earlier projection also implies that tomorrow will begin a steady stream of rate cuts. 

That may be a bit over-enthusiastic.  Even with the last-minute official appointment of Stephen Miran to the Governor seat recently vacated by Adriana Kugler, the failed attempt to remove Lisa Cook might sharpen some of the other members’ resolve toward expressing independence.  That could lead to an even wider than usual spread in the dot plot and more dissents – positive AND negative – than usual.  We created a Forecast contract for that too, by the way.  The expectations are across the board, with “yesses” of 20% for zero dissenters, 33% for one, 17% for two, 24% for three, and 2% for four.  We could come up with scenarios where any of the above can occur.

Finally, let’s hear what Chair Powell has to say at the press conference.  Frankly, he doesn’t have many left before his term expires in the spring.  My gut thinks it’s almost certain that he will stress the need for central bank independence, which could temper expectations for near-term cuts, but do little for longer term expectations.  It is more difficult to predict how he will portray the balance between pressures on both prices and labor.  The FOMC’s Statement of Goals asserts that stable prices are a prerequisite to maximum stable employment.  If he leans upon that, then stocks might not respond kindly.  But if we get another appearance from Goldilocks, the punch bowl remains in place.