COMMENT-Potential for a Fed dot plot projections shock

The Federal Reserve is widely expected to cut rates at its Sept. 18 policy meeting. The bigger question, though, lies in how much they will cut, as the debate over 25 or 50 bps continues (0#FEDWATCH).

After recent payrolls and inflation figures, markets appeared to have clarity over the size of the Fed's September cut, pricing around an 85% chance of a 25 bps reduction. However, as former Fed official Bid Dudley had signalled, there is a strong case for a 50bps.

Meanwhile WSJ's Fed Watcher, Nick Timiraos, has framed the rate cut dilemma debate with arguments on whether the Fed should start big or small. In turn, uncertainty has once again crept into market pricing, with odds of a 50 bps edging higher, now at 40%. That said, given the data in the lead up to the meeting, the risks still lean in favour of a 25 bps cut.

The other question that will need answering is how many cuts are likely by year-end. As it stands, Fed pricing indicates 115 bps of easing over the next three meetings, which means that at least one 50 bps cut is priced in. This is where the dot plot projections will be key from a market perspective.

Fed Chair Jerome Powell has previously playing down the dot plots significance in suggesting where rates will end up, evidenced by the June dots showing only one 25 bps cut in 2024. However, it does guide markets towards the path of least resistance.

Currently, the median dot plot for 2024 is at 5.1%, indicating one cut, this could easily shift towards 4.6%, which would suggest three 25 bps by year-end, leading to an implicit financial condition tightening shock and thus prompting a bid in the dollar.

Anything lower than 4.6% would resemble at least a 50 bps cut in one of the remaining meetings – including the September decision. In comparison to Fed pricing, markets anticipate between 4-5 cuts. As such, there is an argument that a dovish surprise in the dots is relatively high.

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