Where is the Bar for the Fed’s 50bps Rate Cut?

As investors and analysts prepare for the August employment report, discussions are growing regarding the possibility of the Federal Reserve implementing a significant rate cut of 50 basis points (bps) this year.

In a recent analysis, UBS experts examined the scenarios that could lead the Fed to consider such an aggressive move, breaking from its usual cautious approach. The Federal Reserve has already hinted at a transition to a more accommodating monetary policy. Fed Chair Jerome Powell recently remarked that “the time has come for policy to adjust,” although the prospect of a 50 bps cut remains ambiguous.

UBS indicated that while Powell has suggested the potential for more than just a single 25 bps reduction, he has deliberately refrained from clearly endorsing a larger cut, using the term “appropriate” when discussing the timing and pace of future adjustments. This hesitation has fueled speculation about the feasibility of a 50 bps cut.

Analysts at UBS underline that the Fed would likely need to witness “more obvious economic weakness” to persuade a majority of Federal Open Market Committee (FOMC) members that a 50 bps cut is justified and worth the associated signaling risks. Historically, a 50 bps reduction has often been a precursor to recession, signaling considerable economic distress.

Past examples from 2007 and 1990 illustrate that significant rate cuts usually followed sharp declines in nonfarm payroll employment and broad economic downturns. UBS also noted that within the FOMC, while there is support for multiple 25 bps cuts, a larger reduction might face substantial opposition. Some FOMC members, such as Governors Bowman and Waller, may still be skeptical about the necessity for a 50 bps reduction.

In conclusion, while the Fed appears to be moving towards easing monetary policy, UBS suggests that the threshold for a 50 bps rate cut remains high. A more significant downturn in the labor market and overall economic indicators would likely be required to push the Fed to depart from its customary gradual approach.