The Stock Market wants to know the FOMC's Next Move: 25 or 50 Basis Points?

The Stock Market wants to know the FOMC's Next Move: 25 or 50 Basis Points?

As we approach the Federal Open Market Committee (FOMC) meeting scheduled for next week, the financial world is buzzing with speculation. Will the Fed opt for a cautious 25 basis point (bps) cut in the federal funds rate, or will they signal a more aggressive stance with a 50-bps reduction? This decision could significantly sway the stock market in the short term, given its sensitivity to monetary policy adjustments.

Market Sentiment and Historical Context

Historically, September has been an unpredictable month for the stock market, often witnessing volatility. This year, with the backdrop of an inflation battle that has been the most challenging since the early '80s, the stakes are even higher. The Fed's previous signals have oscillated between maintaining rates to combat inflation and acknowledging the need for rate cuts to support economic growth amidst signs of a cooling labor market.

The Case for a 25 bps Cut

Recent economic indicators, including the August CPI report, suggest that inflation might be cooling, but it is still going up every month, just not as fast. A 25-bps cut would be seen as a cautious step, signaling the Fed's desire to support the economy without reigniting inflation fears. This move could be interpreted by the market as the Fed's attempt to strike a balance between trying to control inflation while providing economic stimulus, potentially leading to a moderate positive reaction in stocks.

The Implications of a 50 bps Cut

A 50-bps cut, however, would be a more dramatic signal. Such a move could imply that the Fed perceives more significant economic risks, a looming recession, or a sharper economic slowdown than previously anticipated. While this might initially shock the market, leading to a sell-off due to fears of economic weakness, it could also set the stage for a recovery. This scenario could lead to a flight to safety, with investors moving towards bonds or gold, but also might spur buying in stocks seen as undervalued or in sectors that benefit from lower borrowing costs.

Market Reaction Dynamics

The stock market's reaction will hinge not just on the rate cut itself but on the accompanying Fed statement and the press conference. Investors will parse every word for hints on future policy directions. If the Fed opts for 25 bps but hints at more cuts, markets might react positively, anticipating further monetary easing. Conversely, a 50-bps cut with no clear indication of future actions might lead to uncertainty, potentially causing volatility.

Conclusion: A Watchful Wait

As we approach this critical FOMC meeting, the stock market's reaction will be a blend of immediate sentiment based on the cut's size and the longer-term implications of the Fed's forward guidance. While a 25-bps cut might soothe markets with its implication of steady policy, a 50-bps cut could introduce volatility, initially negative but potentially setting the stage for future gains if interpreted as proactive against economic downturns. Hence, investors and traders are in a state of heightened alert, ready to adjust portfolios based on what Powell does and says at the press conference.

This anticipation underscores the delicate balance the Fed must strike, not just in managing economic health but also in managing market expectations. Next week's decision will not only affect immediate market movements but could set the tone for economic policy and market sentiment for months to come.

By Shawn Loddy

shawn@smladvisory.com