The uncertainty of the Fed meeting is extraordinarily high: four scenarios are possible

• The Fed’s first rate cut comes as economic uncertainty rises.
• US retail sales and jobless claims are of great interest.
• Rate decisions by central banks in the UK and Japan are also key.

Normal or double? That’s the dilemma for the Federal Reserve (Fed), which is set to begin its rate-cutting cycle this week. The dilemma between a 25 and 50 basis point (bps) cut is just one component of the world’s most powerful central bank, which will decide on rates alongside two main partners. Here are the main events of the week.

1) US retail sales to provide last clue before Fed

Tuesday 12:30 GMT. With uncertainty ahead of the Fed’s decision, this critical report on the health of the US consumer will help shape expectations. After a 1% rise in July, core retail sales are expected to have risen 0.2% in August. This would reflect a moderation in consumer spending, indicating a soft landing for the US economy.

A small decline in retail sales would be welcome as it would increase the chances of a 50 bps cut, but a large decline would already have markets worried about an impending recession. A surprise second straight jump would be good for the economy but bad for stocks as the possibility of a 50bps cut would disappear.

For the US dollar, the stronger the better, while gold would benefit from a weak figure.

2) The uncertainty of the Fed’s decision is extraordinarily high

On Wednesday, the decision and predictions are at 18:00 GMT and the press conference is at 18:30 GMT.

This decision by the Federal Reserve (Fed) stands out for two reasons. First, the world’s most important central bank is set to cut interest rates for the first time in more than four years. Second, there is uncertainty about the size of the cut. The Fed likes to broadcast its moves in advance, and this time is different.

With about a 50-50 chance of either a standard 25bps cut or a large 50bps cut, the decision is the most important driver in the market. Basically, stocks and gold will rise by a 50 bps discount, while the US dollar would benefit from a 25 bps discount.

Fed prices. Source: CME Group.

Fed forecasts – also known as “dot plots” – will have the second word. I expect the Fed to balance any decision. A 25 bps cut would likely be accompanied by an outlook for a more aggressive cut, while a 50 bps cut would be followed by caution about the next moves.

In such “big hawkish cut” or “small dovish cut” scenarios, the reaction would be whiplash – investors jumping to one side before more than reversing the initial move.

If a 50 bps cut comes with promises of quick rate cuts, recession fears would arise, weighing on market sentiment. Similarly, a stance calling for a 25 bps cut would disappoint investors who want to see lower rates. I think a balanced outcome is more likely.

The accompanying statement will also try to strike a balance.

Then comes Fed Chairman Jerome Powell and his press conference. He will be asked if he still thinks a soft landing is on the cards. Investors need a confident “yes” for insurance. Avoiding the question or expressing recession fears would weigh on sentiment.

It’s important to note that the Fed’s decision is multi-phased in its responses, which means volatility could be high for long days.

3) BoE can hold rates, voting pattern matters

Thursday 11:00 GMT. The Bank of England (BoE) is expected to leave interest rates unchanged after the August cut. While headline inflation has eased, core prices haven’t been crushed yet.

UK Core PCE. Source: FXStreet

While economic growth stagnated in July, the UK labor market reared its head, reducing the need for any immediate stimulus to the economy.

In addition, the Monetary Policy Committee (MPC) voted to cut interest rates by the narrowest of margins in August – five to four. It was a “hawk cut”, implying a high probability of a break this time.

Assuming a no-change decision, the focus is on the voting model. The economic calendar indicates an estimated 7:2 split in favor of keeping rates steady. A surprisingly wider majority would lift the British pound (GBP), while a narrower one would weaken it.

It is crucial to note that the decision comes a day after the Fed decision and the reaction in GBP/USD will also reflect a comparison of both decisions.

4) US Jobless Claims Trigger High Volatility

Thursday, 12:30 GMT. Regardless of what the Fed decides, Chairman Jerome Powell will insist that the Fed is dependent on data and will certainly repeat his position from August on focusing on the labor market.

This puts emphasis on every job-related data point. While the weekly jobless claims numbers may suffer from noise, they can serve as a “canary in the coal mine” for a potential rapid deterioration in employment.

A figure of around 230,000, as seen in recent weeks, is on the cards. Any jump above 240,000 would scare investors, while a drop below 200,000 would be encouraging.

5) BoJ to give a nod to Yen strength

Friday, early. The Bank of Japan (BoJ) is the only central bank in the developed world still fighting inflation. For years, Tokyo officials have battled deflation by implementing a long period of negative interest rates. Now I’m catching up with the rest of the world.

The BoJ’s rate hike earlier this year – albeit only to 0% – and its calculated rhetoric boosted the Japanese yen (JPY). The currency has also received occasional support from the Ministry of Finance (MoF), which has stepped in to boost its value.

BoJ Governor Kazuo Ueda and his colleagues are set to leave rates unchanged and may reiterate their willingness to raise rates further. They would benefit from the stronger yen, which lowers import prices – especially energy.

If the Fed is dovish and the BoJ is hawkish, it could turn into another spectacular decline in USD/JPY – pulling other Yen crosses down along its flank.

The last word

This is an explosive week. Please trade carefully, especially around the Fed decision.