4 Fed Scenarios and Market Reactions

Summary

• Today’s Fed meeting is one of the most uncertain in years. It will be the first cut in an easing cycle, and markets are almost split between a 25bp (40% chance) and 50bp cut (60% chance). We therefore lay out possible scenarios for the Fed meeting and likely market reactions.
• We look at four possible scenarios: 1) a 50bp cut with a hawkish bias, 2) a 50bp cut with a dovish bias, 3) a 25bp cut with a hawkish bias, and 4) a 25bp cut with a dovish bias.

1. Hawkish 50bp Cut (Our Base Case)

This is my base case because I believe last week’s WSJ and FT articles were meant to guide the market towards a 50bp cut. If not, the articles would be adding market volatility, which is inconsistent with the Fed’s goal of reducing downside economic risks.  In this scenario, the Fed cuts four times in 2024 and five times in 2025. Over 2024-25, this would be 100bp more cuts than in the June SEP.

In this scenario, both equity and gold will likely be up through the end of the week together with some dollar weakening. Yields will probably drop with some steepening across the curve.

2. Dovish 50bp Cut

In this scenario, the Fed cuts 50bp but with an additional 50bp of total cuts compared to scenario 1. The long-term (LT) Fed Funds rate projection would be lowered because the scenario implies the end-2025 FFR at 2.6% (and 4.1% for 2024). I do not think the Fed wants to show the FFR going below its LT value since it would be inconsistent with the soft-landing scenario.

In this scenario, the market will likely not think the Fed is panicking, so equity and gold could rally and the dollar will drop at least initially. The curve will likely bull steepen. Then it will depend on the economic data in the next few weeks to confirm a bearish scenario for the economy (not my base case).

3. Hawkish 25bp Cut (Least Likely)

The Fed could cut 25bp and the dots could be hawkish with just 50bp total more cuts than in the June SEP. I see little chance for this to happen, but if it does the curve would materially bear flatten with equity and gold selling off and the dollar surging.

4. Dovish 25bp Cut (Second Most Likely)

To offset the market and economic impact of cutting only 25bp, the Fed would have a dovish tilt. This scenario would have 100bp total more cuts than in the June SEP and the same dots as in scenario 1: four 2024 cuts (end-2024 FFR at 4.3%), followed by five 2025 cuts (end 2025 FFR at 3.1%).

In this scenario, equity and gold will likely struggle a bit towards the end of the week as the market will see some chance that the Fed could end up just cutting three times in 2024 and by 25bp. This should support the dollar, which could end the week up post-FOMC.

Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)