The Federal Reserve is poised to cut interest rates at its September meeting, but markets are now bracing for a more modest 25 basis point "baby step" reduction rather than the larger 50 basis point cut originally expected.
As of Thursday, the probability of a half-point cut has plunged to just 15% following some stubbornly hot inflation data. The smart money sees the Fed taking a more conservative approach to prevent excessive volatility in funding markets.
"For everyone asking for a 50 basis point cut, I think they should reconsider the volatility that would cause," said Yardeni Research's Eric Wallerstein. "It's not something the Fed wants to risk."
A deeper cut is also often seen as a signal of impending economic turbulence. The last two times the Fed started cutting with 50 basis points in 2001 and 2007, recessions followed shortly after.
Fed Chair Powell will provide more clues on the outlook with updated projections on Sept. 18. But for now, a 25 basis point "mid-cycle adjustment" looks prudent to apply just enough stimulus without overshooting.
While a bigger cut could initially boost stocks, it risks signaling far more economic stress than investors want to see. Traders hope the Fed strikes the right hawkish balance to nurse the expansion without going too far.
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