FOMC Meeting Preview | Will the Upcoming Rate Cut Become a Historic Moment or Spark Concerns of Being Behind the Curve?

The upcoming FOMC meeting will be held on September 17-18. The Federal Reserve will make the decision on interest rates and release the latest quarterly economic forecast and interest rate dot plot.After the end of their two-day meeting, Chair Jerome Powell will deliver a speech at the press conference following the release of the Fed's statement.

Over the past three years, to combat high inflation, Powell has had to keep raising and maintaining interest rates at levels between 5.25% and 5.5%. This Wednesday, he will finally alleviate the burden of high interest rates for the US corporates, residents, and the White House as well. Traders are betting on a 39% chance that the Fed will cut rates by 25bp and a 61% chance of a 50bp cut.

Chisholm, the director of quantitative market strategy at Fidelity, notes that a significant difference between the target federal funds rate and the inflation rate serves as a reliable indicator of robust market returns. When restrictive rates are paired with decreased inflation, it suggests that the Fed has greater leeway to lower rates if necessary, which generally supports the stock market. At present, there is an unusually wide gap between the federal funds rate and the inflation rate.

However, the market will continue to grapple with many new issues.

▶ The question of soft landing or hard landing is still unclear

Over the past year, Wall Street's concerns about an economic recession have dissipated, but the New York Fed's recession probability model now shows that the likelihood of a U.S. recession occurring within the next 12 months has risen again, reaching 61.79%.

Buchbinder, the chief equity strategist at LPL Financial, comments, "As the Fed starts its cutting cycle, markets are still going to be concerned. The economy is slowing down, and with the Fed cutting rates, we are seeing slow growth paired with contained inflation." Amid two jobs reports that were cooler than expected, investors are wrestling with the possibility that the central bank may have delayed its rate cuts too long, potentially paving the way for a recession.

It will not be immediately apparent which scenario will unfold. Buchbinder anticipates that this issue will be debated in the market over the next few months. "This is why you see volatility at these turning points and with policy shifts," he explains. "They simply add to the uncertainty."

▶ The FOMC will also update its forecasts for the U.S. long-term economic growth

The Fed will update its SEP (Seasonal Economic Projections) report, which includes projections for GDP growth, unemployment rates, interest rates, and inflation.

In its latest economic forecast in June, the Federal Reserve projected that the U.S. GDP growth rate would be 2.1% in 2024, with an unemployment rate of 4%, and anticipated only one rate cut before the end of the year. The Fed raised its forecast for the 2024 core PCE price index growth from 2.6% to 2.8%. At that time, only 8 out of 19 FOMC members expected the Fed to cut rates by 50 basis points or more before the end of the year, but these expectations may have changed in recent months.

Multiple economists expect the Fed to raise its year-end unemployment forecast from 4.0% to 4.2%. Investors will also closely watch the anticipated pace of rate cuts for 2024 and how low the FOMC expects rates to go by 2025. The futures market now anticipated that Fed rate cuts would reach close to 3.25% by the end of 2025.

▶ How do stocks perform after the Fed cuts rates?

The variability seen in the last four major rate-cutting cycles illustrates the difficulty in forming broad conclusions. Market outcomes can shift significantly in the year following the initiation of a new easing cycle. For example, the S&P 500 increased by 17.79% in the 12 months after the Fed began its 1995 easing cycle, during which the economy experienced a rare soft landing. Conversely, market returns plummeted over 10% following the onset of rate cuts in 2001, coinciding with the burst of the dot-com bubble.

The stark contrasts between these years can be attributed to differing market fundamentals and the Fed's varying approaches. Lara Castleton, US head of portfolio construction and strategy at Janus Henderson Investors, says“you need to think about why the Fed is cutting rates” to predict market behavior over the next year. The market's response will differ depending on whether it views the central bank as confident and in control—aiming for a soft landing—or as reactionary, cutting rates in response to recession fears.

The good news is that the liquidity environment has become more relaxed recently. Although the Fed Funds Interest Rate remains near its highest level in more than a decade, and the Fed has been selling its securities holdings by $25 billion per month on Treasuries and $35 billion on mortgage-backed securities, the Chicago Fed's Financial Conditions Index still has reached its loosest level since November 2011, which is commonly considered to be accommodative for the stock market.