At a critical moment, the Federal Reserve is ambiguous, what's going on?

The Federal Reserve, after experiencing the most severe inflation since the 1970s, has loosened its monetary policy for the first time. This was seen as a way to loosen the economy, which should have been welcomed. However, economists say that this highly anticipated move this week has been overshadowed by chaotic expectations and market volatility.

Derek Holt, Deputy Chief Economist at Scotiabank, said in a report to clients: "This should be a moment to celebrate, to some extent it is. Unfortunately, the communication between the Federal Reserve and the market has been quite poor, leading to increased volatility in market expectations surrounding the size and pace of rate cuts."

Last week, the probability of a 50 basis point rate cut at the September Federal Reserve meeting soared from less than 20% midweek to nearly 50% later on, initially due to media reports citing former Fed officials as supporting a larger rate cut.

Lou Crandall, Chief Economist at Wrightson ICAP, said: "The Federal Reserve has spared no effort to put the option of a 50 basis point rate cut back on the table."

Mark Chandler, Chief Market Strategist at Bannockburn Global Forex, pointed out that there has rarely been such a evenly matched bet before a Federal Reserve meeting.

Scott Anderson, Chief U.S. Economist at BMO Capital Markets, said: "The market has been actively preparing for dovish messages from Federal Reserve Chairman Powell and the Federal Open Market Committee (FOMC) this week. In my view, this increases the risk of a hawkish surprise, at least temporarily stirring the market."

Many Wall Street economists insist on their call for the Federal Reserve to moderately cut rates by 25 basis points at this week's meeting, but in reality they all say that it is a critical moment now. Some investment banks have expanded their rate cut expectations to 50 basis points. Some people say that the weak August retail sales report on Tuesday may push the Federal Reserve towards a 50 basis point rate cut.

Why is the market so confused?

Ethan Harris, former Global Economic Research Director at Bank of America Securities, said that economists are facing the challenge that the Fed's response to the economy has become unpredictable.

Harris said that most economists believe that the Fed wants to take action gradually, but in the recent rate hike cycle, the Fed has abandoned this approach. Instead, it did not raise rates at the first signs of inflation, but then raised rates significantly.

Before the COVID-19 pandemic, gradualism was an important part of the Fed's script. Harris told MarketWatch via email that this is because the outlook is always uncertain, and the Fed has been trying to avoid being capricious.

Why doesn't the Fed make its intentions clear?

Holt of Scotiabank said that Fed officials may not know what to do and hope to discuss the issue at the meeting. "This is normal," he said "On the other hand, there may be significant disagreements among policymakers, to the extent that there is no clear support to reflect a unified stance. Or it may be that the Fed believes there is no need to intervene in the market when it is falling," Holt added.

Reasons for a 50 basis point rate cut

Lou Crandall, Chief Economist at Wrightson ICAP, said that the long-term concern about the Fed cutting rates by 50 basis points is that it may backfire and exacerbate concerns about the Fed facing economic difficulties. However, investors last week seemed to view this as a more market-friendly Fed move.

He added that recent surveys show that businesses are eager for rate cuts.

Brian Bethune, an economics professor at Boston College, said that U.S. manufacturers are starting to be "defeated" by the strength of the U.S. dollar.

Reasons for a 25 basis point rate cut

Holt stated that there is no urgent need to expand the rate cut scale. Financial markets are functioning well, and the U.S. economy is resilient.

He said that the Fed is more likely to manage the market through smaller rate cut measures. "Cutting rates by 50 basis points now could lead the market into a 'gotcha moment' and set a precedent. They may price in future major moves, which could prompt the Fed to adjust rates faster than they would like."

Antonio Gabriel, Chief Global Economist at Bank of America Securities, said he would stick to the view of a 25 basis point rate cut. "The main message from the meeting should be to maintain a cautious optimism despite downside risks," he said