Moneycontrol Pro Panorama | 25 or 50 bps? It’s a coin toss

Dear Reader,

This week’s main event for markets is the US Fed’s decision on interest rates. Of course, it’s a foregone conclusion that rates will be cut, but to dismiss the importance of this event would be a mistake. For one, it caps a journey that began when COVID upended life globally in 2020. While protecting people’s health was the first priority, central bankers worked in their corner to protect the economy through monetary easing.

Since it happened in a coordinated manner the network effect magnified its impact, the economy stayed healthy, asset prices inflated as money gushed into all available opportunities. Finally, COVID ended. But high inflation did a dance around central bankers trying to tame it, with even the US Fed getting it wrong on the inflation-being-transitory front. Geopolitics upended supply chains, making the fight tougher. But interest rates were hiked higher and higher till inflation was finally brought to heel and the economy was slowed down or even on the verge of a recession according to some indicators. After a long process of monetary whack-a-mole that tired out impatient investors, there appears to be enough confidence that inflation has durably settled at acceptable levels for the US to start cutting rates. The ECB has already commenced it.

What are the signals for investors? My colleague Manas Chakravarty decodes them in this article, finding that the Fed Funds futures price in a rate cut as being certain, but are divided in the middle (probabilistically speaking) on whether the rate cut will be 25 or 50 basis points. Equity markets have moved modestly, but the bond markets have moved sharply. But the really interesting bit is this, that the Fed Funds futures are also factoring in a probability of more than 50 percent of a 200 bps cumulative cut in six months in the Fed Funds rate, to 3.25-3.5 percent. The FOMC, in contrast, has a median forecast of 4.1 percent at the end of 2025! That leaves enough of a spread for disappointment. Don’t miss Chakravarty’s piece, to know more about what could disappoint investors on September 18, how markets could react to the decision and most importantly, what the decision can mean for Indian investors (hint: the news ‘flow’ is good).