The Federal Reserve's Loudspeaker publishes an in-depth analysis: Cut interest rates by 25 or 50

"The Fed's Megaphone" Nick Timiraos' latest article states that Federal Reserve Chairman Powell is currently facing a difficult decision: whether to cut interest rates by 25 basis points or 50 basis points for the first time?

Before discussing this issue, let's first review the recently released economic and employment data, which is mixed: this week's CPI report shows that the strength of housing costs weakens the possibility of a 50 basis point rate cut next week, but another report on Thursday shows that the Fed's preferred inflation gauge may be much milder in August. At the same time, hiring in June and July was weaker than initially reported, while job growth in August improved.

Next week's economic expectations are also important: the quarterly economic forecasts to be released at the next week's meeting by the Fed may further complicate the issue. These forecasts will show officials' expectations for how many rate cuts there will be this year. Economist Foster, who served as a senior advisor to Powell, said that the number of rate cuts in the coming months will be much more important than the size of the initial action. The dot plot released next week is not the final result of the committee's debate, but it may be just as important as the size of the rate cut, especially if officials choose a smaller rate cut. As the market currently expects the Fed to cut rates by over 100 basis points this year, a smaller-than-expected rate cut may lead to a market pullback, tightening financial conditions and pushing up borrowing costs as the Fed lowers short-term rates.

Currently, the debate in the market on the size of the rate cut next week is divided into two camps, each with its own reasons for support.

Reasons for supporting a 25 basis point initial rate cut by the Fed:

1. If the economy appears to be weakening, larger rate cuts can be made subsequently

The Fed usually prefers to make adjustments in increments of 25 basis points, as smaller adjustments give them more time to study the impact of their policy changes. Esther George, who served as President of the Federal Reserve Bank of Kansas City from 2011 to 2023, said: The Fed can say, we can maintain this momentum for a while, but if the situation looks weaker, we can also take stronger measures later.

2. Can avoid triggering an inflation rebound

According to current and former officials, the reason for starting with a smaller rate cut is the assumption that the economy is fundamentally sound. They argue that starting with a 50 basis point rate cut may convey greater concerns about the economy, or lead to market expectations that the Fed will accelerate the pace of rate cuts, which in turn could trigger a market rebound, making it more difficult to contain inflation.

3. Starting with a 50 basis point cut may lead to "mispricing" of future actions by the market

If next week starts with a 50 basis point rate cut, it will mistakenly lead the market to believe that the Fed plans to cut rates by the same amount at the November and December meetings. Brad, who served as President of the Federal Reserve Bank of St. Louis from 2008 to 2023, said in an interview last week that this would create an expectation that the Fed would quickly transition to a neutral interest rate level that neither stimulates nor slows growth Considering that the Federal Reserve tends to establish a broad consensus and faces the challenge of explaining a larger rate cut before the election, starting with a 25 basis point rate cut is the least resistant path.

Supporting the Fed's first 50 basis point rate cut also seems to have reasons to support:

1. Does the Fed still want to maintain a strict stance as the unemployment rate rises?

Chicago Fed President Guersby said in an interview last week that officials need to consider whether they still want to take the most stringent measures throughout the rate cut cycle when the inflation rate is clearly close to 2% and the unemployment rate is higher than the level expected by most Fed officials. When financial markets show greater concerns about the economic outlook, the Federal Open Market Committee responsible for setting interest rates typically cuts rates by a larger magnitude, such as in early 2001 and the beginning of the global financial crisis in 2007.

2. The Fed can dispel concerns about acting too slowly by using a lot of rhetoric

Faust, a researcher at the Johns Hopkins University Center for Financial Economics, said, "I also tend to start with a 50 basis point rate cut. The Fed can completely address investors' concerns about a larger rate cut by providing a lot of rhetoric to make it less scary." Faust said he believes several officials expect a 100 basis point rate cut this year. If that's the case, starting with a 25 basis point rate cut might raise an awkward question: why would officials take larger rate cuts later this year instead of starting with a 50 basis point cut?

3. If the Fed has truly reached a "balance," then a 25 basis point action is meaningless

Dudley, who served as President of the Federal Reserve Bank of New York from 2009 to 2018, said, if the risks between rising inflation and a weak labor market have truly reached a balance, as Fed officials have said, then the Fed should hope that rates are closer to a neutral level. Given that all Fed officials believe rates below 4% are low, starting with a 25 basis point rate cut is meaningless. Logically, they should move faster. In addition, last week's employment report was not particularly reassuring, as the unemployment rate has already risen by 0.5 percentage points since the beginning of the year. Typically, when the unemployment rate rises slightly, it tends to continue to rise, and it will rise significantly. Especially in recent months, the real estate market has been weak, and although the construction industry added jobs in August, the decline in new residential construction suggests that there may be another weak factor in the employment outlook