With the onset of this month's rate cut being taken as a given, focus is now on the size of the cut. As the interest rate decision approaches, uncertainty continues to loom.

Recent mixed economic indicators have resulted in conflicting views from Federal Reserve (Fed) officials. The Wall Street Journal (WSJ) reported that the outlook for a 25 basis points (bp) cut (1bp = 0.01 percentage points, also known as a baby cut) versus a 50bp (big cut) reduction is neck and neck, making the Fed's decision a difficult one ahead of the Federal Open Market Committee (FOMC) meeting on the 17th and 18th.

The August nonfarm payrolls report released on the 6th showed an increase of 142,000 jobs, falling short of market expectations of around 160,000, while job growth figures for June and July were also sharply revised downward, raising concerns. However, the unemployment rate came in at 4.2%, in line with expectations. The Consumer Price Index (CPI) for August, released on the 11th, showed a 0.2% increase month-over-month, matching market expectations. However, the core CPI (excluding the volatile food and energy sectors) rose by 0.3%, slightly higher than the expected 0.2%.

According to the Chicago Mercantile Exchange (CME) FedWatch tool, as of the 5th, the probability of a 25bp rate cut was at 59%, while the odds of a 50bp cut stood at 41%. By the day prior, these probabilities had shifted to 86% for 25bp and 14% for 50bp, before reverting to 57% and 43%, respectively.

Although the Producer Price Index (PPI) for August, released on the same day, mostly met market expectations, analysis of the PPI indicated that the core Personal Consumption Expenditure (PCE) index, a preferred inflation gauge of the Fed, is expected to have eased in August, boosting expectations of a big cut.

The WSJ noted that the Fed generally favors gradual rate cuts, allowing time to evaluate the effectiveness of its policies.

A 50bp cut from the outset could stoke fears of an economic slowdown. Additionally, if the market expects a faster pace of rate cuts, asset prices could rally, making it harder to control inflation. Moreover, implementing a big cut ahead of the November elections could be seen as burdensome.

James Bullard, former president of the St. Louis Federal Reserve Bank, recently stated that a 50bp cut could lead markets to believe that the Fed would quickly reach the neutral interest rate (the rate that neither stimulates nor restrains inflation).

Former Fed Vice Chair Richard Clarida and former Cleveland Fed President Loretta Mester also expressed concerns about market instability due to a 50bp cut. Mester remarked, “While a 50bp cut may be proposed, the communication with the market around it is complex, and there is no compelling reason to take on such difficulties.”

Credit rating agency Fitch predicted that the Fed would make two 25bp cuts, one this month and another in December, adjusting policy at a moderate pace. Fitch also projected that the Fed would cut rates by a total of 125bp next year and a further 75bp in 2026, totaling a 250bp reduction over 10 cuts within 25 months. Fitch explained this relatively gradual pace of rate cuts by noting, “There is still work to be done regarding inflation,” referencing CPI levels that remain above the Fed's 2% target.

On the other hand, some are calling for an immediate 50bp cut due to concerns over economic slowdown, arguing that if a 50bp cut is planned for November or December, it should be brought forward to September.

Former New York Fed President William Dudley suggested that if the Fed’s claims that inflation and employment are balanced hold true, the Fed would prefer to move more quickly to the neutral interest rate. He added, "Logically, a faster rate cut is expected."

Bloomberg reported that Dudley also noted that the current federal funds rate is 150-200bp higher than the neutral rate and that the labor market is at risk of slowing down, saying, “There is a strong argument for a 50bp cut.” Fed Chair Jerome Powell emphasized labor market stability in his keynote speech at the Jackson Hole symposium last month, stating, “While the risk of inflation has decreased, the risk of a decline in employment has increased.”