The Federal Reserve is poised to cut interest rates on Wednesday, with the stock market potentially setting up for a disappointment. Last week, the markets anticipated a quarter-point rate cut and were content that the Federal Reserve was initiating the rate-cutting cycle. Since then, stock prices have reached new all-time highs, with both the S&P 500 and the Dow Jones Industrial Average achieving fresh records during Tuesday’s session.
Currently, fed funds futures show that a majority of traders are predicting a half-point cut, even though most Federal Reserve officials and economists believe the central bank will start with a quarter-point reduction. As of Tuesday afternoon, the CME FedWatch Tool indicates that there is a 63% chance that the federal funds rate will be lowered by half a percentage point to a range of 4.75% to 5% from the current 5.25% to 5.50%. Meanwhile, there is a 37% probability of a quarter-point reduction to a range of 5% to 5.25%.
A week ago, the prevailing theory was that a half-point cut might alarm the market by suggesting that the Federal Reserve was aware of economic issues unknown to the market. However, sentiment has shifted to expecting a half-point cut. According to JPMorgan traders in a Tuesday note, a half-point cut would serve as a “clearing event,” prompting the market to assess other factors such as corporate earnings and the upcoming presidential election in November. They believe this would not induce panic but rather reassure the market by aligning with its expectations for aggressive easing in 2024.
Michael Feroli, JPMorgan’s chief U.S. economist, expressed to CNBC’s “Squawk on the Street” earlier this month that the Federal Reserve should consider a half-point cut at this month’s meeting. He argued that there is a strong case for accelerating the pace of rate cuts.
Conversely, JPMorgan traders suggest that a quarter-point cut would “add to market uncertainty,” potentially hindering the market’s ability to sustain its all-time highs. They noted that a modest 25-basis-point reduction would require the market to adjust its expectations for September and the anticipated easing throughout the end of 2024. The traders emphasized that the only positive outcome from a 25-basis-point cut would be if upcoming labor market data significantly exceeded expectations, thereby justifying the Federal Reserve’s more cautious approach.
