Super-sized rate cut still on the cards for the Fed

Stocks are mostly higher in Europe and the US futures market is pointing to a higher open for the S&P 500 as it climbs back towards July’s record high The positive mood has been spurred by an article in the Wall Street Journal that suggests that next week’s Federal Reserve interest rate decision is a fine balance between a 25bp and a 50bp rate cut. The article by Nick Timiraos, who is considered to the be the closest of the press pack to the Fed, has said that the Fed’s biggest dilemma is whether to start big or to start small. The Fed has already signaled that they are willing to make several cuts to interest rates as the jobs market cools. However, the debate seems to have shifted and the Fed is getting more nervous about keeping interest rates too high for too long, lest a soft landing slips out of their grasp.

The market had shifted away from expecting a 50bp rate cut at next week’s meeting because the economic data has been mixed: the jobs market is definitely slowing, but job creation picked up last month, also core inflation did not fall as expected in August. Next week will also see the Fed release their quarterly projections, and we expect the expectations for growth and inflation to complicate matters for the Fed: inflation could be revised higher but growth projections could be revised lower. Added to this, the FOMC members’ rate cut expectations or ‘dot plot’ will also be vital to determining how far the FOMC will cut rates at this cycle.

A 50bp rate cut next week would be a gutsy move, however, if the Fed signal that they will front load rate cuts, then it could see fewer rate cuts down the line, which could take the market by surprise and weigh on risk sentiment. The market is still expecting the Fed to cut by 25bps next week, however, the chance of a 50bp move has increased in the last 24 hours. The chance of a 50bp move is now 40%, this was 30% a week ago, according to the CME’s Fedwatch tool.

Price action as we move to the end of the week is dominated by the Fed. Stocks are higher, and US futures are predicting a higher open. We have mentioned in previous notes that Nvidia is a good barometer of market sentiment right now, and its stock price has risen by more than 10% in the past week, which has been positive for risk. It is also expected to open slightly higher later today, although we could see some end of week profit taking after such a large move.

An increase in expectations for a 50bp rate cut, has weighed on the dollar. The USD is down across the board, with the biggest losses vs. the JPY. USD/JPY has made a fresh low below 141.00, and is now at its lowest level since 2023. The Fed is dominating FX markets right now, and we expect the dollar to retreat further as we wait for next Wednesday’s FOMC meeting. The euro and the pound could be beneficiaries, as we expect the ECB and the BOE to remain less dovish than the Fed in the coming weeks.

The gold price has made a fresh record high, as it moves inversely to US interest rate expectations. Gold is the ultimate inflation hedge, so it has received a boost from prospects of a 50bp rate cut from the Fed. We also expect gold to trade with an upward bias as we wait for the Fed next week. This is good news for gold miners, including Fresnillo and Barrick. Fresnillo is back at its highest level since early August, and is bucking the trend of a weaker FTSE 100 today.