Federal Reserve Policy Shift: Interest Rate Cut Expected

Federal Reserve Chair Jerome Powell caused a stir at the Jackson Hole conference with the statement "The time has come for a policy adjustment." This clear message suggests that interest rates could be lowered at the next Fed meeting in September. Investors are preparing for the upcoming decision of the Federal Open Market Committee (FOMC) on Wednesday at 8 PM German time. It is considered almost certain that the Federal Reserve will lower the key interest rate from its current level of 5.25%-5.5%. This would be the first rate cut since March 2020, when the central bank drastically reduced rates in response to the pandemic-induced recession. Interestingly, there is still no consensus on the extent of the upcoming rate cut. According to the latest market expectations, reflecting the implied probabilities of the markets, investors anticipate a 50 basis points rate cut with a probability of 59%. The rest foresee a smaller cut of 25 basis points. Historically, the Fed has often started a rate-cutting cycle with a reduction of 50 basis points. However, the overwhelming majority of Wall Street analysts expect a smaller cut of 0.25 percentage points. Their rationale: The economy remains resilient and does not require a significant rate cut, especially considering that inflation is still above the target level. A stronger reduction of 50 basis points could appear politically contentious, as this meeting is the last one before the presidential election in November. In addition to the interest rate decision, the Fed will release its updated summary of economic projections, covering growth, inflation, and the expected path of key interest rates. The so-called "dot plot," which maps the expectations of FOMC members for future rate steps, will also be closely watched. In June, the median dot pointed to only one rate cut by the end of this year, followed by 100 basis points of cuts both in 2025 and 2026. Market participants now expect a more aggressive forecast for rate reductions. The interest rate decision and the economic projections will be announced at 8 PM German time. However, traders will primarily focus on the subsequent press conference by Chair Jerome Powell at 8:30 PM German time. Powell is expected to face tough questions about the rationale behind the decision and the Fed's approach to the upcoming rate-cutting cycle.