Fed to cut rates this week – can stocks rally?
This week’s Fed rate decision will see the first rate cut in four years, and likely the beginning of a sustained process of cuts. But will they cut by 25 or 50 basis points?
The upcoming Fed meeting
The Federal Reserve (Fed) is poised to cut interest rates for the first time since 2020 at its 17-18 September meeting. This decision comes as the Fed attempts to navigate a complex economic landscape, balancing concerns about inflation, unemployment, and overall economic growth.
Options on the table
The Fed is considering two main options for its rate cut:
- A smaller 25 basis points (bps) cut
- A larger 50 bps cut
As of the latest market data, investors are split nearly evenly on which option the Fed will choose, with a slight edge towards the larger cut.
Economic indicators influencing the decision
Several key economic indicators are influencing the Fed's decision:
- The unemployment rate stands at 4.20%, higher than pre-Covid-19 pandemic levels
- Inflation has fallen but remains above the Fed's 2.00% target
- Job growth has slowed but remains positive
These mixed signals make the Fed's decision particularly challenging, as they try to avoid both appearing panicked about the economy and falling behind economic needs.
Market expectations and future outlook
Investors are anticipating about 150 bps of total rate cuts in the near future. Many economists expect cuts to continue at every meeting until mid-2025, with the federal funds rate potentially reaching 3.00-3.25% by the end of 2025.
US rate cuts chart
Potential market impact
The impact on stocks following the rate cut is not straightforward and depends largely on the underlying economic conditions. Historical data suggests:
- When the Fed succeeds in staving off a recession, stocks tend to rally
- When a recession occurs despite rate cuts, stocks tend to decline
The size of the initial cut could significantly influence investor perceptions about the economy's health. A larger 50 bps cut might be seen as a sign that the Fed is behind the curve, potentially triggering a negative market reaction.
Implications for consumers
As the Fed begins its easing cycle, US consumers can expect:
- Lower yields on savings accounts
- Potentially decreased borrowing costs for loans and credit cards
The Fed's balancing act
The Fed is attempting to achieve a "soft landing" by reducing economic restraint without causing a recession. This would be a remarkable achievement given the recent bout of high inflation. While the Fed has managed similar feats in the past, such as in 1995, it remains a challenging and rare accomplishment.
Conclusion
As the Fed prepares to make its decision, market participants will be closely watching not only the size of the rate cut but also the accompanying economic projections and statements. The coming months will be crucial in determining whether this cutting cycle successfully navigates a "growth scare" or leads to a recessionary episode, with significant implications for stock market performance.
This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients.
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