After higher-than-expected inflation figures on Wednesday, markets quickly priced in a greater likelihood that the Federal Reserve will cut rates modestly at its September meeting.
Markets sold off en masse after reports that the Fed would not cut rates by 50 basis points as some had hoped. The S&P 500 (^GSPC) and Dow Jones Industrial (^DJI) both fell more than 1.5% within two hours of the report, before paring some losses.
However, some strategists argue that a 25 basis point rate cut would be a better signal from the Federal Reserve.
Eric Wallerstein, chief market strategist at Yardeni Research, reasoned that the Fed would likely not cut rates by more than 25 basis points “unless there is a recession or a financial crisis.”
“For anyone who’s calling for a 50 basis point rate cut, I think they really need to reconsider how much volatility that would create in the short-term funding markets,” Wallerstein told Yahoo Finance. “It’s just not something the Fed wants to risk.”
To make Wallerstein’s point, while the most recent jobs report showed continued signs of a slowdown in the labor market, economists largely reasoned that the August jobs report did not reveal the substantial cooling that many believed would be needed to prompt the Fed to make a deeper cut. The same can be said of the August consumer price index (CPI), which showed prices rising at the slowest annual pace since early 2021.
However, details in the report show that on a “core” basis, which excludes the more volatile costs of food and gas, prices rose 0.3% in August from the previous month, above Wall Street expectations for a 0.2% increase.
“The unwelcome news on inflation will distract somewhat from the Fed’s renewed focus on the labor market and make it more likely that authorities will stick to a more dovish approach to easing, starting with a 25-year period [basis point] “Interest rates are set to be cut next week,” Michael Pearce, deputy chief U.S. economist at Oxford Economics, wrote in a note to clients on Wednesday.
Further clues about what the Fed expects the rate-cutting cycle to look like will come on September 18 when the Federal Reserve releases its Summary of Economic Projections, including its “dot plot,” which charts policymakers’ expectations about future interest rate trends.
On Wednesday morning, markets were expecting 100 basis points of interest rate cuts from the Federal Reserve this year. Wallerstein reasoned that if the total amount of Fed rate cuts this year falls short of market expectations, that wouldn’t necessarily be bad for stocks.
“If those rate cuts are not factored in because growth is stronger than expected and GDP is strong in the third quarter and labor market indicators are not that bad, and we continue to see consumer spending, [increasing]“Then stocks have more room to rise as earnings continue to rise,” Wallerstein said.
