The First Cut is the Deepest
Powell yesterday did not give an unambiguously dovish signal and the Dollar bounced
In yesterday’s post, I laid out three possible options for the Fed: (i) cut 50 basis points to get ahead of the labor market and Trump; (ii) cut 25 basis points and open the door to two further cuts this year; and (iii) cut 25 basis points and leave forward guidance - for only one further cut in 2025 - unchanged from the June meeting. When the dust settled, we ended up somewhere between (ii) and (iii), which - given the build-up in dovish expectations going into the meeting - saw the 2-year Treasury yield rise and the Dollar bounce.
In my time on the Goldman trading floor, I learned that Fed meetings are very difficult to trade. That’s because there are two distinct and sometimes opposing signals. The first comes at 2 pm when the policy statement and economic projections are released. This signal was unambiguously dovish yesterday, because the median dot showed a total of three cuts in 2025, up from only two at the June meeting. But then everything changed with the start of the press conference. At 2:41 pm, Chair Powell said “there wasn’t widespread support for a 50 basis point cut today,” a comment that was followed at 2:42 pm by “you can think of today’s move as a risk management cut.” Then came “Fed is in a meeting-by-meeting situation” at 2:50 pm and “Situation of two-sided risk means no risk-free path” at 2:52 pm. All this was way more complicated than what the market wanted to hear. As the chart above shows, after its initial fall, the Dollar ended the day stronger.
In terms of the scenarios I outlined in yesterday’s post, we’ve ended up somewhere between (ii) and (iii). Given that - ahead of the meeting - markets had nearly fully priced 75 basis points in cuts through the end of 2025, this was a hawkish surprise. As the Cat Stevens song (I prefer the Sheryl Crow version) says: “The first cut is the deepest.”
The key unknown now is President Trump. If hawkish price action in markets continues and S&P 500 falls sharply, we might get a replay of 2018 when the Fed’s December hike drew withering criticism from the White House. The Fed only a few weeks later made a meaningful dovish shift that resulted in 75 basis points in cuts later that year (the mid-cycle adjustment). One can only hope that this time is different, mainly because Chair Powell’s leadership of the Fed ends soon, which might make him less susceptible to political pressure from the White House.