According to the &#34;Fed Watch&#34; tool of the Chicago Mercantile Exchange, the futures market has priced in a high probability of a significant 50 basis point rate cut by the Fed on Wednesday, reaching 63%, far exceeding the 30% from a week ago. The likelihood of a &#34;routine&#34; 25 basis point rate cut is only 37%.
In other words, after several mainstream financial media outlets such as &#34;Fed News Agency&#34; repeatedly heated up expectations for the Fed's first rate cut following last Thursday, the market's expectation for the magnitude of the Fed's first rate cut suddenly shifted from 25 basis points to &#34;more likely to be a significant rate cut,&#34; but it is still uncertain.
Some believe that the Fed &#34;dare not&#34; make a significant 50 basis point rate cut rashly, as the current US economic data has not reached a crisis level suitable for a significant rate cut. A significant rate cut may instead validate the Fed's behind-the-scenes economic concerns, triggering a stock market sell-off.
However, at the same time, many media outlets considered as &#34;Fed indicators&#34; have published articles in support of a potential significant rate cut, which is another wave that cannot be easily ignored. In other words, more and more market participants are starting to agree that the larger the rate cut, the better.
As summarized by analysts at Edmond de Rothschild, a Swiss private bank, &#34;Given the speculation in the market about the Fed's intentions, there has rarely been such a high level of uncertainty.&#34;
Goldman Sachs derivatives trader Brian Garrett analyzed data on &#34;futures market pricing&#34; and &#34;actual Fed actions&#34; over the past fifteen years and found that during rate hike cycles, the Fed's actions since the Bernanke era have usually been consistent with market pricing. However, there is a certain level of uncertainty during rate cut cycles. For example, during the 2008 financial crisis and the 2020 COVID-19 pandemic, the Fed unexpectedly took a more dovish stance. But in certain cases like September 2019, the rate cut was lower than market pricing.
In a research report, Deutsche Bank pointed out that the media's hype for a significant 50 basis point rate cut by the Fed last week is actually weaker than the momentum before the significant 75 basis point rate hike in June 2022. However, the current market pricing for a rate cut is close to 40 basis points, raising the probability of a surprise rate cut by the Fed to the highest level in fifteen years in two days. &#34;If the media does not counterbalance market expectations in the next two days, there is a high chance that the Fed will indeed make a significant 50 basis point rate cut on Wednesday. Media commentary in the next 12 hours is crucial for consolidating pricing.&#34;
In fact, Goldman Sachs hedge fund sales director Tony Pasquariello believes that the Fed has no reason to choose a 50 basis point rate cut over 25 basis points. Firstly, because Fed officials before the silent period have not endorsed &#34;using a significant rate cut to start a rate cut cycle,&#34; and the CPI data does not support a significant rate cut. &#34;A 50 basis point rate cut is usually only used in high-pressure environments,&#34; unless the Fed wants a &#34;long wait&#34; during the two FOMC meetings from September to November
&#34;Buy a little insurance&#34; for worse job data.
Nomura Securities' cross-asset strategist Charlie McElligott pointed out in a Sunday blockbuster article that, given that interest rates are far from neutral and the labor market is cooling down, it is best to start a new cycle with a substantial rate cut. This seems to echo the tone of Federal Reserve Chairman Powell's speech at the August Jackson Hole Symposium, that the Fed is neither seeking nor welcoming further cooling of the job market.
Moreover, Powell also stated at the time that &#34;the upward risks to inflation have diminished,&#34; which already guided the market to focus on the cooling labor market. This is why the market has priced in a rate cut of up to 121 basis points this year, with September and November both expected to cut rates by 50 basis points. This is also why the two-year U.S. Treasury yield returned to a two-year low last week, and the yield curve has shown a &#34;bull steepening&#34; after the rate cut.
The notoriously acerbic financial blog Zerohedge summarized that since Federal Reserve officials entered a quiet period, in a short period of time, while job and manufacturing data continued to disappoint, several core inflation indicators such as CPI and PPI exceeded expectations. This is also why the market's expectation of a significant rate cut in September did not turn into a &#34;done deal&#34;:
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But this brings us an interesting paradox: whether intentional or not, the Fed seems to be &#34;tentatively&#34; heating up the market through the media for a 50 basis point rate cut, which would trigger market selling for any rate cut below this level. Expectations for a significant rate cut were not fully accepted by the market two weeks ago. On the contrary, at that time, a 50 basis point rate cut was seen as a sign of Fed panic (economic negative signal).
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Zerohedge also mentioned that if the Fed &#34;disappoints and only cuts rates by 25 basis points,&#34; risk assets may face a severe (albeit temporary) downward shock, triggering stop-losses in the G10 sovereign bond market, which has accumulated a three-year high in CTA long trend net exposure, creating a significant &#34;financial tightening shock&#34;:
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&#34;The next focus is how the Fed's 'dot plot' for 2025 interest rates bridges the huge gap with market pricing.
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The market performance in the loose cycle depends on the ultimate destination: whether there will be an economic recession. If a recession is avoided, the broad U.S. stock market will rise by 14% in the 12 months after the first rate cut. If the U.S. falls into a recession within 12 months, the median return of the U.S. stock market in the year after the first rate cut is -15%.&#34;
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Earlier, BlackRock issued a warning regarding the bond market, downgrading its rating on US short-term treasuries from &#34;overweight&#34; to &#34;underweight&#34;. They also warned that the market's expectations for a rate cut by the Federal Reserve are too aggressive and unlikely to materialize. Chief Investment Strategist Wei Li and her team of analysts believe that the speculation that &#34;the Fed has waited too long on easing and will now accelerate rate cuts to support the US economy&#34; is incorrect
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Some analysts believe that the only important thing for the market this week is whether the Federal Reserve chooses to cut interest rates by 25 basis points or 50 basis points. If the rate cut is less than 50 basis points, it may create disappointment and trigger selling in the stock and bond markets, causing a significant "financial tightening shock"

- The futures market, as per the Chicago Mercantile Exchange's "FedWatch" tool, now prices a high 63% probability of a significant 50 basis point rate cut by the Fed on Wednesday, up from 30% a week ago, with only a 37% chance of a "routine" 25 basis point cut.
- Market expectations for the Fed's first rate cut have shifted dramatically towards a larger cut, sparking debates on the necessity and implications of such a move amidst varying economic indicators and expert opinions.
- Despite the uncertainty, the market remains divided on the extent of the rate cut, with implications for asset markets and the broader economic outlook, as highlighted by recent warnings from BlackRock regarding overly aggressive expectations.

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The market expectations are very aggressive. What will happen if the Federal Reserve does not cut interest rates by 50 basis points on Wednesday?