The Federal Reserve will cut interest rates by at least 100 basis points this year? Analysts advise you to stay calm

After a day when concerns about a US economic recession swept through global financial markets, some things became clearer.

Inflation is no longer the focus of traders and investors. Many market participants still hope for multiple rate cuts by the Federal Reserve, and as of Tuesday, they expected at least a full 200 basis points cut by September next year. However, if the actual rate cut by the Federal Reserve matches the extent currently expected by traders, it may bring a series of new issues.

The rate cut by the Federal Reserve is a double-edged sword: on one hand, lowering the benchmark interest rate from the current level of 5.25% to 5.5% can reduce borrowing costs, helping to offset any deflationary or anti-inflationary forces that may result from an economic slowdown; on the other hand, rate cuts may encourage people to take risks in the stock market, generating a wealth effect similar to the first half of 2024 and boosting consumer demand, thereby reigniting worrying inflation trends. However, the latter point remains a controversial issue.

Gang Hu, managing partner and trader at New York hedge fund WinShore Capital Partners, said, "One issue the market hasn't really thought about is whether a rate cut by the Federal Reserve will make inflation worse rather than better."

Hu said on Tuesday over the phone, "If the market believes that potential rate cuts by the Federal Reserve are already lagging, then the rate cut is because it needs to counter the pressure from the economic slowdown. If potential rate cuts by the Federal Reserve are seen as leading, then the Federal Reserve will stimulate an economy that doesn't need to be stimulated, and inflation will rise."

On Monday and Tuesday, US Treasury yields indicated that the market is more concerned about an economic slowdown. Tradeweb data showed that the yields on 5-year, 10-year, and 30-year Treasury Inflation-Protected Securities (TIPS) all closed below 2% on Monday for the first time since early March.

Additionally, derivative-like instruments - the trading levels of fixed-income swaps on Tuesday implied that the annual inflation rate based on the Consumer Price Index should fall below 2% in the first half of next year.

According to the CME Group's FedWatch Tool, traders are betting that the Federal Reserve will cut rates by at least 100 basis points to between 4.25% and 4.5% by the end of the year. They also believe that by September next year, the probability of cutting rates by another 100 basis points or more is close to 75%.

Tim Magnusson, Chief Investment Officer at Garda Capital Partners in Minnesota, said, "The Federal Reserve has enough room to cut rates," but how policymakers will ultimately act is another matter. "The market believes that the Federal Reserve has achieved its goal, and I have no objection to that," he referred to the Federal Reserve's goal of inflation falling to 2%.

Magnusson said, "The Federal Reserve can cut rates now, and it is entirely reasonable for them to do so."

In Hu's view, a significant rate cut as expected by the market above may come at a high cost He said that multiple interest rate cuts will "strongly promote asset prices, support housing prices, increase inflationary pressures, and attract off-market capital inflows," even though the Fed may be able to cut rates by 25 to 75 basis points this year without having too much impact on the economy and inflation.

Hu said that once the Fed starts cutting rates, "you will see inflation may start to rise again. The question now is whether the rise in inflation will make the Fed uneasy."