The Federal Reserve is anticipated to cut interest rates on Wednesday, yet the stock market may be setting itself up for disappointment. Last week, market expectations were for a quarter-point rate cut, and there was satisfaction with the onset of the cutting cycle. Subsequently, stocks surged to an all-time high, with the S&P 500 and the Dow Jones Industrial Average reaching new records during Tuesday’s session.
Currently, fed funds futures indicate that a majority of traders are predicting a half-point cut, despite most Federal Reserve officials and economists believing a quarter-point cut is more likely. As of Tuesday afternoon, the CME FedWatch Tool shows a 63% probability that the federal funds rate will be reduced by half a percentage point to a range of 4.75% to 5% from the existing 5.25% to 5.50%. The chances of a quarter-point reduction to a range of 5% to 5.25% stand at 37%.
A week ago, the prevailing theory was that a half-point cut might alarm the market under the assumption that the Fed was aware of economic issues unknown to the markets. However, sentiment has shifted from that initial fear to an expectation of a half-point cut. According to JPMorgan traders in a Tuesday note, a half-point cut would serve as a “clearing event,” enabling the market to focus on other significant factors such as corporate earnings and the upcoming November presidential election. This would not incite market panic but rather affirm the market’s expectations for assertive easing measures in 2024.
JPMorgan’s chief U.S. economist, Michael Feroli, stated earlier this month on CNBC’s “Squawk on the Street” that the Federal Reserve should cut rates by half a point at this month’s meeting, citing a strong rationale for accelerating the pace of rate reductions.
Conversely, JPMorgan traders believe that a quarter-point cut would “add to market uncertainty,” implying that it is unlikely the market will sustain its record highs with such a cut. They noted that a 25 basis point cut would necessitate the market to adjust its expectations for September and the aggressive easing anticipated for the entirety of 2024, potentially reducing it from 120 basis points to 100 or 75 basis points. Essentially, the only positive market outcome following a 25 basis point cut would be a series of stronger-than-expected labor market data over the next month, which would validate the decision for a limited cut.
