The Federal Reserve’s anticipated decision to lower interest rates has sparked confusion and market volatility, raising concerns among economists.
Despite being seen as a potential relief in response to the most significant inflation spike since the 1970s, the unclear communication from the Fed has left markets on edge.
Economists like Derek Holt, vice president of Scotiabank Economics, argue that the central bank’s poor communication on the size and pace of the rate cut has intensified market volatility.
“What unfortunately mars the occasion is that the Fed is communicating rather poorly with markets,” remarked Holt.
Earlier last week, the odds of a more substantial 50-basis-point rate cut increased from 20% to almost 50%, after media reports cited former Fed officials favoring a more aggressive reduction. This shift, according to experts like Lou Crandall from Wrightson ICAP, suggested that the Fed was actively reconsidering a half-point cut. Market expectations, however, remained highly uncertain, leading to concerns about possible sharp reactions in financial markets.
“The market is already positioned aggressively for a dovish message from Jay Powell and the FOMC next week. That raises the risk, in my mind, of a hawkish surprise that could whipsaw markets at least temporarily,” said Scott Anderson, chief U.S. economist at BMO Capital Markets.
While many analysts still expect a 25-basis-point cut, some have shifted to predicting a larger, 50-basis-point reduction. Economists point out that a weak August retail sales report could influence the Fed’s decision toward the more significant move.
One of the challenges driving the uncertainty is that the Fed has become less predictable in its policy responses. According to Ethan Harris, former head of global economics research at Bank of America Securities, the Fed has strayed from its previous gradualist approach, making it harder to anticipate its actions.
The debate on the size of the cut reflects broader differences in opinion. Proponents of a 50-basis-point cut, like Crandall, argue that such a move would demonstrate a more market-friendly stance by the Fed. However, there is also concern that it could raise fears of looming economic trouble. Meanwhile, economists like Brian Bethune of Boston College emphasize the negative impact of a strong US dollar on manufacturers, potentially supporting the case for a larger cut.
On the other hand, analysts like Holt contend that there is no pressing need for a larger cut. Financial markets, in his view, are functioning well, and the US economy remains resilient. He warned that a large cut could set a precedent, leading to future market expectations for similarly substantial moves, which could constrain the Fed’s ability to manage rates gradually.
With input from Market Watch, Fortune, and CNBC.
