Warmer-than-expected readings on consumer prices — and some wholesale prices — over the past two days have led markets to price higher if the Federal Reserve will opt for a smaller, more conservative interest rate cut at its September meeting.
A larger reduction could result in reeling stocks.
On Thursday, investors put the odds of the Fed cutting rates by 50 basis points at next week’s meeting at just 15%, down from the 44% chance seen a week earlier, according to the CME FedWatch Tool.
Some strategists say a 25-basis-point cut would be a better sign from the Federal Reserve.
Yardeni Research market strategist Eric Wallerstein stressed that the Fed is unlikely to cut more than 25 basis points “absent a recession or an emerging financial crisis.”
Read more: What the Fed’s rate decision means for bank accounts, CDs, loans, and credit cards
“For everybody who’s asking for a 50 basis point cut, I think it’s worth reconsidering the amount of volatility that’s going to cause in the short-term funding market,” Wallerstein told Yahoo Finance. “It’s just not something the Fed wants to risk.”
To Wallerstein’s point, while the latest jobs report shows signs of a continued slowdown in the labor market, economists generally have reason not to reveal the substantial cooling that many believe is needed to get deeper cuts from the Fed. The risk is that a significant deterioration in the labor market indicates a recession.
Meanwhile, Wednesday’s Consumer Price Index (CPI) report showed that on a “core” basis, which excludes more volatile food and gas costs, prices in August rose 0.3% over the previous month, above Wall Street’s expectations for a 0.2% rise.
“Unexpected news on inflation will somewhat distract the Fed’s focus on the labor market and make more officials stick to a more measured approach to easing, starting with a 25 (basis point) cut next week,” said Oxford Economics. US chief economist Michael Pearce wrote in a note to clients on Wednesday.
Some on Wall Street also said that a 50-basis-point interest rate cut could send a more dire signal about the health of the U.S. economy than the central bank expected.
“A cut of 50 basis points would be panic, and it almost feels like we’re behind the curve at this point,” Jennifer Lee, senior economist at BMO Capital Markets, told Yahoo Finance.
DataTrek’s founder, Nicholas Colas, analyzed every Federal Reserve rate cut cycle since 1990. Among the five rate cut cycles during that time period, twice the Fed started the cycle with a 50 basis point cut (in 2001 and 2007), a recession soon followed. followed.
“While the data here is sparse, there is something to be said for associating an initial cut of 25 basis points with a midcycle policy correction and 50 basis points as a sign that the Fed is too far behind the curve to avoid a recession,” Colas wrote. in a note to the client on Friday morning. “Chairman Powell and the rest of the FOMC are certainly aware of this history. The first cut is almost certainly 25 basis points.”
As of Wednesday morning, the market expected 100 basis points of cuts from the Federal Reserve this year. Another clue to the Fed’s thinking will come on September 18 when the Federal Reserve releases its Summary of Economic Projections, including a “dot plot,” which reflects policymakers’ expectations of future interest rates.
Wallerstein stressed that if the number of Fed cuts this year falls short of market expectations, this will not necessarily be a problem for stocks.
“If the rate cuts come at a price because growth is stronger than expected and GDP is strong for the third quarter and labor market indicators are not too bad, and we continue to see consumer spending (increase), then stocks will have more room to run. as income continues to grow,” Wallerstein said.
Josh Schafer is a reporter for Yahoo Finance. Follow him in X @_joshschafer.
Click here for in-depth analysis of the latest stock market news and stock price moving events
Read the latest financial and business news from Yahoo Finance
