Half a point or a quarter?

The Federal Reserve goes into its September meeting divided over how to begin cutting rates: with the standard 25 basis points, or a more forceful 50. Bond markets have swung back and forth, and the odds of a half-point cut have jumped around after pointed commentary in the press.

Why the press matters this week

The swings reflect a vacuum. Fed officials entered their pre-meeting blackout on 7 September, the day after a soft August jobs report, and have said nothing in public since. With policymakers silent, well-sourced newspaper reports about the committee's thinking become the only fresh signal, and futures traders reprice on every one. The market is moving on interpretation rather than data.

The last public words were finely balanced. On 6 September Fed governor Christopher Waller said the time had come to start cutting and that he was open to larger moves if the data deteriorated. John Williams, president of the New York Fed, also backed a cut without committing to its size. Both left the door to 50 basis points ajar without pushing it open.

The Fed has itself to thank for the sensitivity. Over the past two decades it has trained markets to expect few surprises, signalling its moves well in advance through speeches, minutes and projections. When officials leave a genuine choice open going into a blackout, traders have little to go on except the reporters with the best access, and the price of a futures contract can move on a single paragraph.

Reading the signal

A 25-basis-point cut would signal calm and deliberation. It would also risk leaving the Fed behind the curve, given how fast the labour data are cooling. A 50-basis-point cut would give growth immediate insurance, but could cause alarm by suggesting that the Fed sees trouble nobody else has spotted. How the Fed explains its choice will probably matter more than the size of the first cut.

What first cuts have meant

History explains the nervousness. The Fed opened with quarter-point moves in 1995, 1998 and 2019, and each time the economy kept growing. It opened with half-point moves in January 2001 and September 2007, and both times a recession followed within months. Markets have learned to read the size of the first cut as a verdict on the economy, whatever the committee intends.

The pattern may confuse cause and effect. The Fed cut by half a point in 2001 and 2007 because it already saw trouble, not because the larger cut produced it. A bold move taken early, before the data turn, could in principle have the opposite effect to those episodes, buying insurance rather than signalling distress. The committee's task is to persuade markets that this is what it is doing.

The arithmetic favours boldness

The case for the larger move rests on how restrictive policy has become. With the policy rate at 5.25 to 5.5 per cent and inflation on the Fed's preferred measure at about 2.5 per cent, the real rate has risen simply because inflation has fallen while rates stood still. A half-point cut would remove only part of that squeeze. Officials who fear the labour market is weakening faster than the figures show can argue that a quarter-point is a rounding error.

The counterargument is also strong. Growth has held up, weekly jobless claims remain low and core inflation is still above target. A half-point cut seven weeks before a presidential election would invite charges of politics, however unfair. A Fed that starts big may also find markets demanding more of the same at every meeting.

Who gains either way

The distributional effects are clearer than the signalling. Borrowers on floating rates, from small businesses on bank lines to households carrying credit-card balances, gain in proportion to the size of the cut. Savers in money-market funds lose the same amount. A bigger cut would also tend to weaken the dollar, which helps American exporters and emerging-market borrowers with dollar debts, and it would narrow the gap with Japanese rates that fuelled the carry-trade unwind of early August, a risk the committee will not have forgotten.

Abroad, the European Central Bank meets this week and is expected to cut again, and the Bank of England has already begun easing. A Fed that moves slowly while others cut would keep the dollar strong; a Fed that moves boldly would take pressure off other central banks.

The data and the dots

The August consumer price figures, due on Wednesday, are the last big data point before the meeting. The committee will also publish new projections; in June the median official pencilled in only one cut for this year, and a sharp downward shift in that path would reinforce any half-point move. Mr Powell will then have to explain whichever course the committee chooses.

The projections may matter more than the decision. A quarter-point cut accompanied by a path showing several more cuts by the end of the year would deliver much of the easing that a half-point move promises, while avoiding the alarm. A half-point cut with a cautious path could have the opposite effect. Dissents are also possible, and a split vote would itself be read as a sign of how uncertain the committee feels.

Short-dated Treasuries are the likeliest beneficiaries of either decision, since both confirm that the easing cycle has begun. Whether the Fed cuts by 25 or 50 basis points is mostly a question of what the move signals. Its task is to protect jobs without frightening markets, and the press conference will do more of that work than the decision itself. Whatever the size, expect projections pointing to further cuts before the year ends, with floating-rate borrowers the clear winners and cash savers giving up yield from next week.