The big debate on Wall Street — a Fed rate cut — is back in the spotlight.
This time, the issue is not whether the Jerome Powell-led central bank will take action at its September meeting, but the size of the rate cut: 25 or 50 basis points.
Calls for a 50 basis point rate cut have been mounting in recent weeks as a weakening labor market has prompted calls for more aggressive action from the Fed to prevent further economic deterioration.
But despite all the whining and doomsday scenarios, strategists and economists told me this week that a 50 basis point rate cut would send the wrong signal to markets: a signal that the central bank is too late to intervene.
“A 50 basis point rate cut would cause panic. It almost feels like we are completely behind the times at this point,” warned Jennifer Lee, senior economist at BMO Capital Markets.
She added: “We are putting on the brakes… But the fact that the US economy has held up all this time says a lot about its resilience.”
Lee points to upwardly revised second-quarter GDP growth, resilient consumer spending and the lack of mass layoffs as factors supporting her call for a more dovish approach, adding that a soft landing “is in the cards.”
A bigger cut could also raise alarm bells among investors. Eric Wallerstein of Yardeni Research told me that a jumbo cut would likely cause volatility and signal that the economy is “headed in the wrong direction.”
“Anyone who is calling for a 50 basis point rate cut, in my opinion, really needs to rethink the level of volatility that would create in short-term financing markets,” Wallerstein said.
The two seasoned assessments are in line with the expectations of Goldman Sachs chief economist Jan Hatzius, who told Yahoo Finance editor in chief Brian Sozzi this week that he expects a series of 25 basis point rate cuts (though he didn’t completely rule out a 50 basis point cut next week).
With less than a week until the Fed’s decision, traders are pricing in a nearly equal chance of a 25 versus 50 basis point cut. On Friday, the odds of a 50 basis point cut rose to 49%, up from 30% a week ago.
At the heart of the rate cut debate is the risk of a recession, a concern that has plagued Wall Street for years.
Jim Paulsen, a veteran market strategist, told me in Opening Bid (video above; listen here) that the persistent recession fears aren’t necessarily a reflection of deteriorating economic performance. Rather, they’re a result of multiple factors: the shock of the pandemic, the polarizing political climate, and the collapse of recession-forecasting tools.
“Every recession tool we’ve ever used to predict recessions is either blown up or simply doesn’t work anymore,” Paulsen warned. “We’re rudderless on how to price recession risk.”
The inverted yield curve, slowing money supply growth and the Conference Board’s Leading Economic Index (LEI) all point to a recession and are causing concern on Wall Street.
While the Federal Reserve’s rate cut on Wednesday is unlikely to resolve the ongoing recession debate on Wall Street, it should provide some near-term clarity for investors.
If market experts are right, the size of the rate cut could signal that the economy is at greater risk of weakening. This could rattle financial markets and tip the recessionary signs firmly in one direction.
Fasten your seatbelts.
Seana Smith is an anchor at Yahoo Finance. Follow Smith on Twitter @SeanaNSmith. Tips on deals, mergers, activist situations or anything else? Email seanasmith@yahooinc.com.
Three times a week, Yahoo Finance Executive Editor Brian Sozzi fields insightful conversations and chats with the biggest names in business and markets on Opening bid. You can find more episodes on our video hub or look at your preferred streaming service.
In the Opening Bid episode below, former Trump Federal Reserve candidate Judy Shelton shares her views on the economy.
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