Be careful what you wish for! Is the significant rate cut by the Federal Reserve not a good thing after all?

Before the release of this week's inflation report, the question is not whether the door to rate cuts will be opened, but whether the Federal Reserve will choose to quietly enter a rate-cutting cycle or act hastily.

After the release of US CPI and PPI data, the situation seems to have been clarified a bit: now, the market expects a higher likelihood of a 25 basis point rate cut in September, but more aggressive measures are still possible.

Comments following the CPI data release indicate that the Federal Reserve is still weighing various variables, but is more likely to lean towards a slow start.

Lauren Goodwin, Chief Market Strategist at New York Life Investments, said, "While we have plenty of time to prove this, we do not believe today's data suggests an urgent need for the Fed to cut rates by 50 basis points in September. Economic momentum is slowing, but indicators suggesting the economy may have entered a recession (such as a significant increase in unemployment claims or deteriorating business prospects) have not yet flashed red lights."

As the market begins to take a more cautious and less urgent stance, traders in the federal funds futures market believe there is a 56% chance that the Federal Reserve will choose to raise rates by 25 basis points at the Federal Open Market Committee (FOMC) meeting on September 17-18. The stock market is indifferent to both scenarios.

On Tuesday, data showed that US PPI rose by only 0.1% in July, leading to a sharp rebound in major stock indices. The following day, CPI recorded a 0.2% month-on-month increase and a 2.9% year-on-year increase, both hitting their lowest levels since spring 2021, with the stock market only slightly higher. In the bond market, longer-term bond yields mostly declined, but the 2-year Treasury yield, sensitive to policy changes, remained stable. Overall, the market is still expecting the Fed to act quickly to ease.

Liz Ann Sonders, Chief Investment Strategist at Charles Schwab, stated that if the Fed delays action, it could trigger a strong market reaction, but a larger rate cut could signal more serious issues.

Sonders said, "If the labor market deteriorates more than we've seen, it could trigger a more aggressive stance. Be careful what you wish for when hoping the Fed takes more aggressive action."

History shows that compared to a slow rate-cutting cycle, a rapid rate-cutting cycle does not bring returns to the stock market. Currently, pricing in the federal funds rate futures market indicates that after a rate cut in September, the Fed will cut by 50 basis points in November and another 25 basis points in December.

However, pricing in the interest rate futures market this year is more volatile than in previous years, with the market now seemingly more concerned about the Fed acknowledging a potential deterioration in the labor market. Tani Fukui, Macroeconomist at MetLife Investment Management, said, "I am indeed concerned that the Fed is basically fighting its last battle." "The last time the Federal Reserve fought inflation was in 1980, when the inflation rate was around 15%. Now, as core personal consumption expenditures (PCE) approach 2%, this is a completely different world, and I think we are overthinking it." Fukui noted the rise in unemployment rate and its potential signs of triggering an economic recession, but she believes that the economy has not truly contracted yet.

She said, "On inflation, I will not play such a trick (referring to causing the economy to fall into recession) in pursuit of perfection. A one-time large rate cut of 50 basis points will alleviate this pressure to some extent."