The Fed's biggest interest rate meeting in years will take place on Wednesday. Here's what you can expect

Despite all the hype surrounding them, Federal Reserve meetings are usually fairly predictable affairs. Policymakers announce their intentions in advance, markets react, and everyone has at least a rough idea of ​​what will happen.

Not this time.

This week's meeting of the Federal Open Market Committee has been shrouded in unusual mystery. While markets have collectively agreed that the Fed will cut interest rates, there is fierce debate about how far policymakers will go.

Will it be the traditional quarter-percentage point or 25 basis point rate cut, or will the Fed take an aggressive first step and cut the benchmark rate to 50 or half a percentage point?

Fed watchers are uncertain, suggesting the possibility of an FOMC meeting that could have even greater implications than usual. The meeting ends Wednesday afternoon, with the Fed's interest rate decision due at 2 p.m. ET.

“I hope they cut rates by 50 basis points, but I suspect they'll only cut by 25. I'm hoping for 50 because I think rates are just too high,” said Mark Zandi, chief economist at Moody's Analytics. “They've achieved their goal of full employment and brought inflation back to target, and that's not consistent with a target rate of about five and a half percent. So I think they need to normalize rates quickly and have a lot of room to do that.”

Pricing on the Fed's actions was volatile in the derivatives market.

By the end of last week, traders had been committed to a 25 basis point cut. Then on Friday, sentiment suddenly shifted and half a point was possible. As of Wednesday afternoon, Fed funds futures traders had priced in about a 63 percent chance of a deeper cut, a relatively low level of conviction compared to previous sessions. One basis point is equal to 0.01 percent.

Many on Wall Street continued to predict that the Fed's first move would be more cautious.

“Although tightening seemed to work, it didn't work quite as well as they expected. So easing should be viewed with just as much uncertainty,” said Tom Simons, U.S. economist at Jefferies. “So if you're uncertain, don't rush into anything.”

“They should act quickly here,” said Zandi, taking the more moderate view. “Otherwise they run the risk of something breaking.”

The debate in the FOMC chamber is likely to be interesting and will likely see an unusual split among officials who have normally voted unanimously.

“I guess they're split,” former Dallas Fed President Robert Kaplan told CNBC on Tuesday. “Some at the table will feel, as I do, that they're a little late to the game, and they'd like to go on the offensive and not spend the fall chasing the economy. Others will just want to be more cautious from a risk management perspective.”

Beyond the 25 vs. 50 debate, it will be an action-packed Fed meeting. Here's an overview of what's on the agenda:

The FOMC has kept its key interest rate in a range of 5.25% to 5.5% since the last hike in July 2023.

That's the highest level in 23 years, and it remained that way even though the Fed's preferred inflation measure fell from 3.3% to 2.5% and the unemployment rate rose from 3.5% to 4.2% during that period.

In recent weeks, Chairman Jerome Powell and his colleagues have left no doubt that there will be a cut at this meeting. The decision as to how much will involve a calculation between fighting inflation and the fact that the labor market has weakened significantly in recent months.

“For the Fed, it comes down to deciding which risk is greater – renewed inflationary pressures with a 50 basis point cut or a looming recession with a cut of just 25 basis points,” said Seema Shah, chief strategist at Principal Asset Management, in a written commentary. “Having already been criticized for responding too slowly to the inflation crisis, the Fed will likely shy away from reacting to recession risk rather than being proactive.”

At least as important as the interest rate cut will probably be the signals that the meeting participants send about what future interest rate developments they expect.

This will be done using a so-called “dot plot”, a grid in which each official presents his assessment of developments over the next few years. The September diagram will provide a first outlook for 2027.

In June, FOMC members planned only one rate cut by the end of the year. This trend is almost certain to accelerate, with markets pricing in rate cuts of up to five or 1.25 percentage points (assuming a rate cut of 25 basis points) with only three meetings remaining.

Overall, traders expect the Fed to cut interest rates next year, cutting the current federal funds rate by 2.5 percentage points before cutting the benchmark rate entirely, according to CME Group's FedWatch futures indicator.

“That seems overly aggressive unless you know that the economy is going to weaken significantly,” Zandi said of the market outlook. Moody's expects cuts of a quarter of a percentage point each at each of the three remaining meetings this year, including this week's meeting.

The dot plot is part of the FOMC's summary of economic projections, which also provides unofficial forecasts for unemployment, gross domestic product and inflation.

The biggest adjustment the SEP will likely have to make is in unemployment, which the committee will almost certainly raise from the 4.0% forecast for the end of the year in June. The unemployment rate currently stands at 4.2%.

Core inflation, set at 2.8 percent for the full year in June, is likely to be revised downwards, having last been at 2.6 percent in July.

“Inflation is expected to be below the FOMC's June projections, and the higher numbers earlier in the year increasingly resemble residual seasonality rather than a revival. A key theme of the meeting will therefore be a focus on labor market risks,” Goldman Sachs economists said in a statement.

In addition to the adjustments to the dot plot and SEP, the committee's post-meeting statement must also be amended to reflect the expected rate cut as well as any other forecasts the committee will add.

The statement and SEP, released at 2:00 p.m. ET, are the first things the market will react to, followed by the Powell press conference at 2:30 p.m.

Goldman expects the FOMC “will likely revise its statement to sound more confident about inflation, more balanced in its portrayal of the risks to inflation and employment, and reiterate its commitment to maintaining maximum employment.”

“I don't think they're going to be particularly specific about a forecast,” said Simons, the economist at Jefferies. “A forecast isn't very helpful at this point in the cycle when the Fed doesn't really know what it's going to do.”