Experts warn big moves would be a mistake

Wall Street’s great debate — a Fed rate cut — is back in the spotlight.

This time, it’s not whether the Jerome Powell led central bank will act at its September meeting, but rather, the size of the cut: 25 basis points or 50.

The case for a 50 basis point reduction has grown louder in recent weeks, as a weakening jobs market has prompted calls for more aggressive Fed action to avoid further economic deterioration.

Yet despite the handwringing and doomsday scenarios, strategists and economists told me this week a 50 basis point cut would send the wrong message to the market — one that signals the central bank is too late to act.

“A 50 basis point cut would reek of panic, and it’s almost like we’re totally behind the curve at this point,” BMO Capital Markets senior economist Jennifer Lee warned.

She added, “We’re tapping on the brakes… But the fact that the US economy has held up all this time speaks to the resilience of it all.”

Lee points to the upwardly revised second quarter GDP, resilient consumer spending, and lack of mass layoffs among factors supporting her call for a more measured approach, adding a soft landing is “in the cards.”

A larger cut could also raise the alarm for investors. Yardeni Research’s Eric Wallerstein told me a jumbo cut would likely spark volatility and signal the economy is “heading in the wrong direction.”

“For everyone who’s asking for a 50 basis point cut, I think they should really reconsider the amount of volatility that would cause in short-term funding markets,” Wallerstein said.

The pair of veteran assessments is in line with Goldman Sachs chief economist Jan Hatzius, who told Yahoo Finance executive editor Brian Sozzi this week he expects a series of 25 basis point rate cuts (though didn’t completely rule out a 50 basis point cut next week).

With less than a week until the Fed decision, traders are pricing in near-even odds of a 25 versus 50 basis point cut. As of Friday, the probability of a 50 basis point cut rose to 49%, up from 30% one week ago.

At the heart of the rate cut debate is the risk of a recession, a concern that’s plagued Wall Street for years.

Long-time market strategist Jim Paulsen told me on Opening Bid (video above; listen here) the ongoing fear of recession isn’t necessarily a reflection of deteriorating economic prints. Rather, it’s attributable to multiple factors: the shock of the pandemic, the polarizing political environment, and the breakdown of recession forecasting tools.

“Every recession tool that we’ve ever used to predict recessions has blown up or just has quit working,” Paulsen warned. ”We’re left rudderless on how to assess recession risk.”

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The inverted yield curve, slowing rates of money supply growth, and the Conference Board’s Leading Economic Index (LEI) have all signaled a recession, leaving Wall Street anxious.

While it’s unlikely the Federal Reserve’s rate cut decision on Wednesday will resolve Wall Street’s ongoing recession debate, it should offer some near-term clarity for investors.

If the market pros are right, the size of the rate cut could signal whether the economy is at greater risk of weakening, which could potentially rattle financial markets and sway recession calls firmly in one direction.

Buckle up.

Seana Smith is an anchor at Yahoo Finance. Follow Smith on Twitter @SeanaNSmith. Tips on deals, mergers, activist situations, or anything else? Email seanasmith@yahooinc.com.

Three times each week, Yahoo Finance Executive Editor Brian Sozzi fields insight-filled conversations and chats with the biggest names in business and markets on Opening Bid. You can find more episodes on our video hub or watch on your preferred streaming service.

In the below Opening Bid episode, former Trump nominee to the Federal Reserve Judy Shelton shares her outlook for the economy.

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