Fed Reserve's 50bps cut is the necessary size for global knee-jerk effect
50bps is the right size for US Federal Reserve to more accurately gauge its impact on the global economy
Why do we think this is a right size?
The questions posed during Jerome Powell’s Q&A with the media were framed with implications suggesting the Federal Reserve might have acted too late, is lagging behind economic conditions, or views the economy as weakening, necessitating a significant rate cut. The dissent from Governor Michelle Bowman—the first since 2005—underscores the intensity of the debates preceding this decision, indicating this decision was far from frivolous. Most, if not all, media outlets have pointed out that there were no clear signals leading up to this move. This shows that the decision was made at the very last minute, following extensive deliberation.
If they have opted for a 25bps cut, we project that the impact would have been smaller, and the time required for it to take effect would have been longer...this minimal impact could again be misinterpreted as a sign of weakness, even if gradual progress is made.
Based on the Fed’s past decisions and actions, it is clear they do not wish to set a predetermined course, as seen during their rate hiking cycle. As Fed Chair Jerome Powell emphasized during the Fed meeting, “I do not think that anyone should look at this and say, ‘Oh, this is the new pace.” We think that this is due to the market’s tendency to anticipate and move ahead of expectations, which could make it even more challenging for the Fed Reserve to adjust course if inflation resurfaces.
We can reasonably conclude that this decision was carefully considered and appropriately sized to allow the Federal Reserve to assess its impact not just on the U.S. economy, but on the broader global market. Despite speculation that the Fed is behind the curve, the data suggests otherwise. Given recent indicators—strong consumer confidence, improved retail sales, tamed CPI and PPI, and stable employment data—this is well-timed move to make a 50 basis point cut when the market is still in good condition.
If they have opted for a 25bps cut, we project that the impact would have been smaller, and the time required for it to take effect would have been longer. Given the recent misalignment between the Federal Reserve and the market in early August, this minimal impact could again be misinterpreted as a sign of weakness, even if gradual progress is made. We would expect the stock market to overreact in such a scenario, and if that happens, a subsequent 50bps cut might exacerbate the situation, potentially leading to a further market decline. This unnecessary spiral could artificially create the conditions for a recession through widespread panic—something that could have been avoided with a more decisive approach.
Market perspective
While the market initially welcomed the 50bps cut with a sharp rise across indexes, by the close, all major indexes—S&P 500, Nasdaq, and Dow Jones—were down. We hypothesize that the stock market is currently divided between two groups of investors: those advocating for a consistent 50bps cut in subsequent meetings, seeking certainty for hyper-growth in their investments, and those favoring a more deliberate approach, aiming for reasonable conditions that support a soft landing.
We believe the latter group is better positioned for long-term gains through 2025, as it aligns with projections for improved and sustainable growth conditions for businesses. The former perspective, which seeks a return to pre-rate hike conditions that once drove stock prices higher and benefited traders, risks reigniting inflation. We advise investors to advocate for a balanced approach that promotes steady growth without jeopardizing the broader economy, which is in line with the Federal Reserve’s current strategy.
...hypothesize that the stock market is currently divided between two groups of investors: those advocating for a consistent 50bps cut in subsequent meetings, seeking certainty for hyper-growth in their investments, and those favoring a more deliberate approach, aiming for reasonable conditions that support a soft landing.
One key lesson investors can take from the market's reaction in September 2023, following the Fed's statement about possible future rate hikes (despite having paused hikes since June 2023), is that the demands of speculative investors are highly unlikely to be satisfied in the near term. However, long-term investors who align with the Federal Reserve's vision tend to fare better. While the market experienced a brief decline in September and October, it was followed by strong gains in the subsequent months, reinforcing the value of patience and long-term thinking.
We believe that the perspective of returning to rapid, stimulus-fueled growth will only fuel unhealthy investor euphoria, which is detrimental to the long-term economy. The rapid growth driven by low rates and pandemic stimulus was necessary to counter the dire circumstances of the pandemic. However, without a similar crisis, a more balanced rate environment will support sustainable growth rather than hyper-growth. The Federal Reserve must also consider the possibility of future pandemics or related crises when planning for future easing, ensuring they retain options to respond effectively when needed.
Next cut probability
- We believe the current market reaction will be short-lived. Investors with unrealistic expectations who exited during this dip may miss out on the growth potential of an economy that remains fundamentally healthy.
- A clearer picture will emerge during upcoming earnings calls, as we closely monitor companies' projections for the next year, particularly their operational and marketing expenses.
Although the updated FOMC projections suggest that the Fed will cut by 25 basis points in the final two meetings, we still see the possibility of a 50bps cut in the next meeting if the following conditions are met:
Our prediction is based on the current strategy and approach taken by the Federal Reserve Committee during this rate cut. If the Fed chooses to front-load larger cuts while economic conditions remain favorable, this would significantly improve the chances of achieving a soft landing—balancing both inflation and the job market. This strategy would then allow for smaller, 25bps cuts in the future when the odds of a soft landing are more secure.