The decision we have been waiting for for weeks will come this week

The leading US stock index, the S&P 500, is only 1 percent short of its record high reached in mid-July, while market participants await the Federal Reserve’s interest rate decision on Tuesday and Wednesday. There will definitely be an interest rate cut, the only question is whether the US central bank will start easing monetary conditions with a 25 or 50 basis point cut.

This week, the stock market fluctuated somewhat more than usual, while more and more people expect a bigger interest rate cut. Based on Chicago Mercantile Exchange futures, they now give a 50-50 chance of a quarter and a half percent cut, after the labor market appears to be faltering and concerns are growing that the rate cut is coming too late.

– he said Anthony Saglimbenechief market strategist at Ameriprise Financial a to Reuters.

From this point of view, the Fed’s recent economic forecasts and the expected interest rate trajectory will play an important role. They are currently pricing in a 115 basis point reduction until the end of 2024, according to data from LSEG late on Friday. In comparison, the Fed’s forecast in June predicted a reduction of only 25 basis points by the end of the year.

Walter Toddaccording to the investment director of Greenwood Capital, the central bank should cut by 50 basis points on Wednesday. According to him, this is indicated by the fact that 2-year US government bonds are around 3.6 percent, while the Fed base rate is between 5.25 and 5.5 percent. This difference indicates that the Fed may indeed be lagging behind what the market sees. They start this cycle of downsizing late and need to catch up.

Aggressive interest rate cut expectations contributed to the wave of price increases seen in US government bonds. The 10-year yield has fallen by around 80 basis points since the beginning of July, to around 3.65 percent, which is close to the lowest level since June 2023.

If they cut a little, the stock market can punish you

However, if the Fed continues to signal significantly less interest rate cuts, the bonds will reprice and this may lead to a wave of sales and an increase in yields. Rising yields could put pressure on valuations for stocks, which are already high relative to their historical averages. According to data from LSEG Datastream, the S&P 500’s most recent average price-to-earnings ratio (P/E) calculated with expected results is 21, compared to the long-term average of 15.7, he pointed out Mike Mullaneydirector of global analysis at Boston Partners.

With the S&P 500 already up about 18 percent so far this year, it won’t take much for next week’s Fed meeting to disappoint investors.

After the moderation of inflation, the focus of attention is now on the labor market. The increase in the number of jobs in the last two months was smaller than expected, the unemployment rate jumped to 4.2 percent in August. All this barely a month after the Fed published its forecast, in which it predicted this level only until 2025. This also makes it likely that the interest rate cut could be larger. If this does not happen, it may be poorly received by the stock market.