The Fed may "plant the seeds for the first rate cut in September", the magnitude of the rate cut still remains uncertain!

As US inflation softens and concerns about the economy overheating diminish, economists are now quite certain that the Federal Reserve will cut interest rates in September for the first time in this cycle. What will happen next remains to be seen. Diane Swonk, Chief Economist at KPMG Economics, said: "The road is bumpy, and the Federal Reserve is walking a tightrope, making things difficult." Over the past year, the Federal Reserve has kept the policy rate stable in the range of 5.25%-5.5%. This is well above the "neutral" rate level close to 3%, as the Federal Reserve has kept the policy rate high to slow demand and curb inflation. Federal Reserve officials have not even begun discussing their views on a broader cycle of monetary easing. Economists have divided themselves into two main camps. Some believe that the Federal Reserve will "readjust" rates, cutting rates by 75 or 100 basis points, then pausing after the first cut; while others believe that the Federal Reserve will pause after the first cut and then plan a series of steady rate cuts to bring the benchmark rate closer to the neutral level of around 3%. Derivatives market traders belong to the latter group. They have already priced in a 175 basis point rate cut, which would bring rates down to the range of 3.5%-3.75 by next summer. For some economists, this is reminiscent of January this year when the market expected six 25 basis point rate cuts in 2023. Michael Gapen, Chief US Economist at Bank of America Securities, wrote in a client report: "We believe the market is once again becoming overly optimistic about the upcoming rate cycle." The Federal Reserve's own forecasts suggest a slower pace of rate cuts. The latest "dot plot" forecast indicates that the Federal Reserve will cut rates four times in 2024, essentially once per quarter. Stephen Brown, Deputy Chief North America Economist at Capital Economics, believes that the Federal Reserve will cut rates in September, skip November, and resume a steady rate cut in December, bringing rates down to 3.5%-3.75% by next summer. Brown does not believe his forecast indicates that the Federal Reserve is preparing for a significant rate cut. He said: "This is essentially based on our return to a more normal economic situation, so there is no need for restrictive policy expectations." Brown added: "Each 25 basis point hike will still be relatively gradual. The speed of emergency rate cuts should be 50 basis points or more at each meeting." Matthew Luzzetti, Chief US Economist at Deutsche Bank, believes that the Federal Reserve will cut rates by 25 basis points for the first time in September, followed by two more cuts in November and December. After that, the Federal Reserve will pause rate hikes until September 2025 Lusardi pointed out that this will be similar to the Fed's actions in the early 1990s and 2019, when the Fed was making mid-term adjustments rather than fighting a recession. He said that the Fed will only start cutting interest rates further when the labor market begins to weaken. In addition, it is widely acknowledged that the fiscal policy of the new U.S. president next year may disrupt the policy trajectory. Federal Reserve officials are scheduled to hold a meeting next week, with expectations from the market that the Fed will keep interest rates unchanged. Economists at the Oxford Economics Research Institute stated in a report to clients that they expect Fed officials to "lay the groundwork for the first action in September" at this meeting