Tonight, the Federal Reserve is set to cut interest rates for the first time in five years, and as the decision approaches, the suspense over the extent of the rate cut continues to escalate.
Wall Street is in a heated debate over whether it will be "50 or 25 basis points," and market uncertainty has suddenly increased.
How will the Fed's "rate cut journey" begin?
At 02:00 AM on Thursday (September 19th), the Fed will announce its September interest rate decision, followed by a speech by Fed Chairman Powell at 2:30 AM.
Currently, a Fed rate cut is almost a "done deal," but the extent of the cut remains uncertain.
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Neither recent inflation nor non-farm reports have been able to "seal the deal" on the extent of the rate cut, leaving the market wavering between a 50 or 25 basis point cut.
Now, during the Fed's quiet period, media "leaks" of a 50 basis point cut have led market expectations to lean towards this camp.
As of now, the market's bet on a 50 basis point rate cut has jumped significantly to 60%, up from just 30%.
Wall Street is divided, with concerns about the labor market and the Fed being "behind the curve," with one side calling for a 50 basis point rate cut; the other side, concerned about persistent inflation and wanting to keep options open for future rate cuts, calls for a 25 basis point rate cut.
However, whether it's 25 or 50 basis points, the market is likely to be severely shaken.
The market is now heavily betting on a 50 basis point cut, and if the Fed cuts rates by 25 basis points, it will be seen as "hawkish," causing a risk shock in the market.
Analysts say that the current record bets locked in with the Fed's consensus rate cut of 50 basis points, if officials choose the standard rate cut, the market will face staggering losses.
92% of economists expect this scenario, and if the Fed takes unexpected action, the federal funds will be forced to reprice significantly, causing losses across all asset classes.
Since last weekend, trading in October federal funds futures has soared to the highest level since 1988, and more worryingly, data shows that most of these new bets are aimed at a 50 basis point rate cut, with positions surging this week alone.
And if a 50 basis point rate cut is chosen, such a sharp rate cut cycle implies that the economy is in trouble, but economic forecasts and corporate earnings expectations remain quite optimistic.
Analysts believe that this seems to be a completely contradictory message, expecting both a significant rate cut in the US and continued strong earnings growth.
Historically, rate cuts usually lead to a 20% or more decline in reported profits, so earnings are expected to decline by more than 30%.
Moreover, without a significant improvement in economic conditions, the pace of subsequent rate cuts may also be slower than the market expects.
If the Fed is perceived by the market as slowing down, the Financial Conditions Index (FCI) will tighten again, leading to lower oil prices, downward inflation expectations, which may put upward pressure on real interest rates and boost the dollar's strength.
Equally important as the rate cut is the "dot plot."
Considering that the Fed will release the latest 2025 interest rate path "dot plot" at this meeting, the market will seek clearer guidance from the Fed on the future pace and range of rate cuts, which will also affect the market performance in September to some extent.
David Wilcox, who once led the Fed's Research and Statistics Department and is now the Director of US Economic Research at Bloomberg Economics, said: The end-of-year dot plot has now become particularly important, and it is obviously more closely watched because the Fed is on the verge of starting a rate-cutting cycle.
Specifically, the dot plot will show the divergence of opinions within the FOMC, such as how many members favor further rate cuts in November and December, especially if a large number of members tend to favor a more significant rate cut of 50 basis points before the end of the year, which would signal that the Fed may take more aggressive action in the future.
The release of the dot plot will directly affect the market's pricing of interest rates.
Since the disappointing July employment report was released at the beginning of August, traders have been betting that there will be a total reduction of 100 basis points in rate cuts by the end of the year.
If the dot plot shows more members supporting a larger rate cut, the market may adjust asset pricing accordingly, pushing market expectations further down.
If the "dot plot" released this time shows that the median forecast of the policy rate is back to the level of March or lower, it will mean that the Fed's monetary policy stance is more dovish.
In addition, the Fed will also release forecasts for unemployment, GDP, and inflation data.
Analysts expect that the biggest adjustment in September may be related to the unemployment rate, and the Fed is almost certain to raise the unemployment rate from 4.0% in June, with the current unemployment rate at 4.2%.
Inflation expectations may be lowered, with the full-year core inflation forecast at 2.8% in June and core inflation at 2.6% in July.
Goldman Sachs said in a report that inflation seems to be lower than the FOMC forecast in June, and the rise in inflation at the beginning of the year looks more like a seasonal factor rather than a re-acceleration, so a key theme of this meeting will be to shift the focus to labor market risks.
In addition to adjusting the dot plot and economic forecasts, the FOMC's post-meeting statement will also be revised to reflect the expected rate cut and the committee's other forward guidance.
Goldman Sachs expects that the FOMC may revise its statement to something similar: to be more confident about inflation, to describe inflation and employment risks as more balanced, and to re-emphasize its commitment to maintaining full employment.
Thomas Simons, an economist at Jefferies, believes: I think they won't give any specific forward guidance, and at this stage of the cycle, when the Fed actually doesn't know what they are going to do, forward guidance is almost useless.