This week, the main event for the markets is the Federal Reserve meeting, where the regulator will announce its decision on monetary policy. The question is not whether the Fed will lower rates but by how much.
There are two possible outcomes: a 25-basis-point cut or a 50-basis-point cut. Analysts' opinions and market expectations are divided this time, and it is not clear why.
Most brokerages, including JP Morgan and UBS, expect Powell & Co. to opt for the smaller cut. BlackRock also sees no reason for a more aggressive move. Some even argue that a larger cut would be a mistake.
10x Research recently suggested a 0.5% cut would indicate severe economic concerns. However, expectations of a more moderate Fed decision triggered a market rally last Friday.
It is not entirely clear why the regulator should take this step. From a macroeconomic perspective, which ideally should guide such decisions, there are few compelling reasons for a drastic cut.
Starting with inflation: while August CPI met expectations at 0.2% m-o-m, core CPI rose 0.3% m-o-m (vs. 0.2% in July), beating the 0.2% expected.
On the labor market front, the number of new claims for unemployment benefits rose slightly last week, suggesting that layoffs remain low.
Initial claims for state unemployment benefits rose by 2,000 to a seasonally adjusted 230,000 in the week ending September 7. Economists had expected 230,000 claims for the week.
Accelerating core inflation and a stable labor market should have settled the debate about a significant rate cut. In addition, analysts at BIS Research have urged the world's major central banks not to deplete the rate cushions they have built up in recent years by cutting rates too quickly.
Nevertheless, according to CME Group data, bond markets have raised the odds of a 50 basis point cut by the Fed to 61% for some unknown reason.
What if the base scenario plays out?
Typically, when regulators make decisions that don't align with market expectations, sentiment can deteriorate. We might also see the "buy the rumor, sell the news" effect.
Goldman Sachs expects XAUUSD to drop if the Fed cuts rates by only 0.25%. Overall, most forecasts aren't too optimistic about how investors will react.
Concerns about what might trigger a larger Fed rate cut include potential issues with carry trades involving the yen, the possibility of an AI bubble, and geopolitical factors.
These issues may influence the Fed's decision in the future, but not necessarily now.