Market Thoughts – Wednesday 18th September – Time For J-Pow To Step Up

Where We Stand – ‘Where we stand’ this morning is simple – we’re all here, waiting, patiently or otherwise, for 7pm London/2pm NY, and for the FOMC’s September policy decision to be announced.

Such is the intense focus on the Fed, I shall skip the usual comprehensive recap of yesterday’s trade, as it pales into insignificance ahead of Chair Powell’s big moment later. In short – it was a flat day for equities, with stocks giving up early gains, despite Treasuries trading softer across the curve. The August US retail sales print beat expectations – rising 0.1% MoM – for the fifth straight August in a row, while US industrial production also delivered a big beat, rising 0.8% last month. Hardly data that cries “50bp cut today!”.

Elsewhere, however, we might get such a move. Canadian CPI fell to 2.0% YoY in August, its lowest level since February 2021, spurring bets on a 50bp BoC cut next month, particularly after Governor Macklem touted such action last weekend.

Tuesday’s only other notable datapoint came from Germany and was, in keeping with recent trends in Europe’s largest economy, utterly dismal. The latest ZEW survey showed the expectations index falling to 3.6, well below the prior 19.2, and its lowest level since October 2023. Good news is, clearly, in short supply in the eurozone at present, and with the EU Commission becoming something resembling a farce, things might not get much better any time soon.

Look Ahead – Right, it’s finally here. It’s like all participants’ birthdays and Christmas have come at once. It’s Fed Day!

Of course, markets come into today’s FOMC decision incredibly divided, albeit certain that a cut of some description will be delivered. The sell-side consensus favours a 25bp move. The USD OIS curve prices the meeting as a 45% chance of 25bp vs. 55% chance of 50bp. Fed fund futures are a touch more dovish, at 40% of 25bp vs. 60% of 50bp.

My own base case, for what it’s worth, is:

• A 25bp cut, via unanimous vote
• A statement acknowledging that risks to each side of the dual mandate are now ‘in balance’, and that the removal of further policy restriction will hinge on incoming data
• Dots pointing to at least 75bp of cuts (in total) this year, followed by another 100bp in 2025
• A relatively dovish press conference, where Powell reiterates that policymakers do not seek further labour market weakness, and are prepared to respond forcefully if it occurs, implicitly leaving the door open to a 50bp cut further down the line

Let’s see how many of those are right, or wrong, later on. I do acknowledge, however, the risk of a 50bp cut, and comparatively more hawkish guidance, were policymakers seeking to deliver an outcome more in line with market pricing, even though I disagree that such action is warranted by incoming economic data, with inflation still above target, and the labour market, as near as makes no difference, still at full employment.

As for the likely market reaction to the FOMC, things are rather more difficult to call than usual, given the knife-edge nature of market expectations.

Logic would argue that a 25bp move results in a knee-jerk move lower in risk, while a 50bp move would see risk rally, at least in the ultra-short-term. However, I do subscribe to the argument that a larger cut will lead to potential market panic, as participants ponder what the FOMC know, which we may not, that has prompted them to deliver such an unusually aggressive start to the easing cycle. Of course, any post-decision moves are liable to reverse ‘in the blink of an eye’ during the presser.

Once the dust settles, though, I still struggle to see a bear case for equities, with the path of least resistance continuing to lead to the upside; dips remain buying opportunities. My bull case all year has had three parts, all three of which remain in place – strong earnings growth, solid economic growth, and a forceful ‘Fed put’.

In fact, that ‘Fed put’ is the most important consideration today. If we’re all honest, we know that whether the Fed cut 25bp or 50bp today doesn’t matter that much – to markets, or to the broader economy. Instead, focus should be on how quickly the remaining policy restriction – let’s say, give or take, 200bp of it – is removed, and rates return to a ‘neutral’ level.

Other G10 central banks have, thus far, followed a ‘slow and steady’ approach to this, delivering 25bp cuts around once per quarter, and treading carefully. Were the FOMC to opt for the ‘hurry up and get on with it’ approach that markets price, with >200bp of cuts in the curve by next July, headwinds facing the greenback are likely to intensify significantly, while the policy outlook is likely to become a fillip for sentiment into year-end – even more so if said cuts are accompanied by the end of QT.

Signals on the pace, and magnitude, of future cuts, and how long it’s likely to take us to return to neutral, are the main things I’ll have my eye on later today.