Nick and Greg blur the lines

Two and a half years after the start of a cycle that lifted money market rates from 0% to 5.5%, the Federal Reserve is preparing to ease monetary policy. The numerous signals sent out over the summer leave no room for doubt. The FOMC will cut the Fed funds rate on Wednesday. A week ago, most observers were expecting a measured move, involving a 0.25% rate cut, but expectations are now leaning in favour of a 0.5% cut, taking the key rate to between 4.75% and 5%.

This last-minute change is largely attributable to an article by Nick Timiraos of the Wall Street Journal, which discusses the dilemma facing the FOMC: should it start with a small cut or a big one? Rightly or wrongly, Nick Timiraos is seen as an informal conduit of information used by the Fed to shape expectations. In other words, this journalist seems to have privileged access to central bankers. If this is the case, then his article is not trivial, but is designed to prepare Wall Street for a 0.50% cut. In the past, leaks orchestrated by the Fed were echoed by Greg Ip, who has also just written a plea for an initial 0.50% cut. That was all it took to turn expectations in that direction, causing dollar yields to ease and renewed appetite for risky assets, which wiped out the losses suffered last week.

Ironically, recent reports have highlighted persistent inflationary pressures. Excluding energy and food, both consumer and producer prices posted monthly changes of 0.3% in August. Year-on-year, ‘core’ inflation remains at 3.2%, a long way from the 2% target (which has, however, been achieved over the last five months). The rebuilding of consumer confidence and the reduced level of initial jobless claims do not justify precipitous action by the Fed.

Beyond the outcome of Wednesday’s meeting, the trajectory of interest rates is more important than the size of the first cut. Consequently, investors will be paying close attention to the forecasts to be unveiled on Wednesday. The 1.25% cut expected today looks very generous and implies a tangible risk of disappointment and hence of a bond market correction. On the other hand, projections that confirm expectations should have little impact on short-term yields, but could imply a steeper slope and greater pressure on long-term yields.

In Europe, the ECB delivered the 0.25% rate cut that was widely expected. The statement and press conference did not include any specific signals, but reaffirmed the authorities’ desire to adjust monetary policy, meeting after meeting, on the basis of a wide range of data. An interest rate cut in October is therefore neither a foregone conclusion, nor can it be ruled out. In short, the ECB still favours a gradual adjustment that should lead to more or less neutral conditions during 2025. After the Fed and the ECB, the Bank of England will hold a meeting on Thursday. A majority of economists believe that the central bank will take a pause after cutting its key rate on August 1st. However, the prospect of faster interest rate cuts in the US has had an impact on the sterling yield curve and, to a lesser extent, on the Swiss franc capital market. To conclude the series of central bank meetings, the SNB is expected to cut its key interest rate from 1.25% to 1% on September 26th.