The Fed will cut rates on Wednesday: will the half-point clamor operation succeed?

At the end of August, in Jackson Hole, the FED told us what he plans to do (and not just this week). The rate-cutting process will begin on Wednesday. Jerome Powell gave us a clear idea of ​​what is essential: the clear direction of travel. The time has come to lower the overly taut sails of monetary policy. A quarter of a point? Half a point? No, more.

The Fed Funds rate has been set at 5.5% since July 2023. Inflation over the last twelve months is at 2.5%. That is three full points of the real rate. They represent a dangerous corrosion to landing the economy softly. The FED needs inflation to converge to the 2% target. But it is in no hurry. According to the median of its projections, it would only arrive in 2026. And with a short-term rate much lower than the current one. Not 25 or 50, but 225 basis points lower. That is where we are going.

The Fed is in no hurry, but the markets are. “Starting with a quarter point makes a lot of sense to me”he stated Patrick Harker, Philadelphia Fed in Jackson Hole. It’s about starting the journey, not the shape of the first step. The rate cut is not an isolated event, it is a process, just like the rate hike. The initial stride does not determine what is really important, the magnitude of the journey. The 2022-2023 rate hike was a massive 525 basis points. For the record, the opening kickoff was a modest quarter point.

Now it’s time to retrace our steps. It could have been at the July meeting. And even, taking more risks, at the June meeting. Should it compensate for the delay by starting with a half-point cut as Bill Dudley, former head of the New York Fed, suggests? It is not obvious. Even if the markets take their toll, as we already saw with a black Friday and Monday at the beginning of August. This time, there is no need to put out any fires.

Inflation, which is under control, may still hold some surprises, as was also seen this week. Its most dangerous component, the cost of housing services, is extremely sensitive to the interest rate. And if there is one thing the Fed hates, it is making a solemn false step. Lowering the rate only to raise it again would be a reputational mistake that would lead to caution.

Rate cuts: How did other central banks act?

The rate cut has been expected since December when Powell revealed it as an official intention. At the G10, Switzerland was the first to do so in March. The ECB launched its first cut in June and last week triggered the second cut. Canada has already made three cuts. England, Norway and New Zealand have also taken the downward path. The common denominator is that none of them used a half-point dose, not even those who repeated. Canada could consider it, suggested Tiff Maklem, its head, only in his fourth intervention.

The Fed says the risks to fulfilling its dual mandate (price stability and full employment) are balanced. This is not true. Rapidly rising unemployment was not on its radar in June, and it was out of line. A confession on the part of one party is a relief from evidence. Powell has already said that the FED will not tolerate further weakening of working conditions. It is a line in the sand that is very easy to cross. What is being discussed is whether it will initially be moved by a quarter of a point or two. However, John Williams himself, of the New York FED, has said that the ground is ripe for a succession of cuts. It will thus be difficult to close the door to a rapid, albeit staggered, reduction of a full point. If necessary, even before the end of 2024.

Predictions: A Closed Discussion

The novelty, however, is the clamorous operation in favor of the initial half-point. The Wall Street Journal and the Financial Times suddenly agreed in pointing out that the decision will be resolved by the edge of a fingernail. Nothing suggested such a close discussion. Is it information from within? A wink from Powell? Or is it speculation from outside? The rise in unemployment benefit claims was the excuse that gave rise to the crisis. However, it is enough to look at the figures, especially without seasonal adjustment, to dismiss its relevance.

A sample button: the unemployed who collect the subsidy for loss of work are 1.2% of the population with coverage, invariably, week after week, since March 2023. But it is easy to spread a rumor like that when the central bank has its mouth shut due to the radio silence prior to the meeting. Even more so if there is money positioned behind the version. With little money, Chicago futures jumped on Thursday after hours, and attracted attention. But they held up all Friday. According to his lens, the chances are 50% and 50%.

Curious, because of the legion of FED speakers who paraded before the press embargo, there was not a single one who showed a preference for starting with a half point. Did they change their mind? If not, given that the data did not change, will the FED allow itself to be dragged into such a move? Will it want to receive forward guidance from investors instead of managing it? That alone should seal the fate in favor of the quarter point. Even, as was said, if the foreseeable cost is a tantrum from the markets, which may well be for renting balconies.

A quarter point of movement doesn’t define anything. Except for the most important thing: to convey that this is not an emergency. When the Fed pivoted with half a point in 2001 and 2007, what followed was a recession. And that is where the Fed is in a hurry. If it opens with a quarter point, and disappoints the inflated expectations of urgency, it will be enough for the decision not to be unanimous to calm the waters afterwards. It will remind the exalted of the most obvious thing, that they must continue participating.