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The most anticipated event risk next week is the Federal Reserve’s interest rate decision. Going into the meeting, the market is now pricing in an 68 percent chance of a 50bp rate cut and an 32 percent chance of a 75bp rate cut.
This indicates that the market believes 25bp will be the minimum that the Fed eases on Wednesday. We believe that a 75bp rate cut will be a too aggressive because it leaves the central bank with next to no room to cut interest rates in case things get worse – and they will.
The 3 most realistic options are:
1. 50bp rate cut
2. 50bp coordinated easing along with other central banks
3. 25bp rate cut
A coordinated easing will probably have the most significant impact on the financial markets and given the drop in oil prices and the deterioration in European economic data, the ECB and the BoE may not be opposed to this option.
Although the Fed may have considered a 25bp rate cut earlier this week, they know that if they under deliver now, the consequences for the equity market could be severe. A larger interest rate cut could put a stop to the dollar’s rally.