Investing.com -- The Federal Reserve looks set to deliver a "dovish" quarter point rate cut next week, leaving the economy exposed to risks of softer economic data that would likely pressure the central bank into a reactive 50 basis point cut in November.
The clear base case though is a 'dovish 25' that falls a bit flat, leaving the Fed, markets, and economy exposed over an intermeeting period that generates a mix of soft and scarier weak data, and likely ends with the Fed delivering a 50 in November," Evercore ISI said in a note.
Cutting by 25 basis point rather 50 basis point doesn't present a risk on the day, but in 7-week run up to the November meet. During this intermeeting period, any bad macro news – such as a dud September employment report – would likely be met with worries that the Fed is behind the curve and a recession could be the horizon, generating an financial condition index shock that might also turn a close election.
"There is a high risk of some weak news during this period, as political uncertainty favors soggy spending, cautious hiring and perhaps a bit more firing," it added.
Still, the signs of slowing inflation as evident by the recent producer price index data, released Wednesday, leaves the door open to dovish surprise of a larger rate cut in September.
"Recognizing that the Fed can surprise dovish right now, whereas it cannot surprise hawkish, we think PPI sustains a lingering possibility of a starter 50, which would take less risk with the soft landing," it added.
The recent producer price index for August came in hotter than expected, but showed soft components that align with the Fed's preferred PCE measure of inflation, suggesting inflation pressures may be easing. While this may have potentially eased jitters from FOMC following a core CPI print for August that overshoot estimates, Evercore ISI believes. Fed officials "will be more sensitive to the trend in housing services than volatile components of inflation in PPI."
August headline and core PPI, the latter of which food and energy, came in slightly above expectations on a monthly basis, printing at 0.2% and 0.3%, compared with 0.1% and 0.2% expected respectively.
Markets are currently pricing in a 25bps rate cut after the Fed concludes Sept. 17-18 meeting, with the odds of a 50bps cut at about 26%, according to Investing.com's Fed Rate Monitor Tool.