Fed interest rate decision looms in critical week for markets: What to know this week

Stocks managed to secure solid wins ahead of a critical monetary policy decision from the Federal Reserve, which has investors on edge over how aggressively the central bank will bring down interest rates.

The tech-heavy Nasdaq Composite (^IXIC) led markets higher to nab its best week of the year, up about 6%. That weekly best was echoed by the benchmark S&P 500 (^GSPC), which saw an uptick of 4% as both gauges notched their fifth straight day of gains on Friday. The Dow Jones Industrial Average (^DJI) also ended the week in the green, up around 3%.

The positive swings come as traders have flip-flopped on whether the Federal Reserve will cut rates by 25 basis points or opt for a more robust 50 basis point cut at the end of its two-day policy meeting on Wednesday. No matter the size, it will be the first rate cut from the Fed since early 2020.

Former New York Fed president Bill Dudley said there's a "strong case" for a deeper cut as FOMC members attempt to maneuver a "soft landing" of the economy. That, along with reports from the Financial Times and the Wall Street Journal that suggested policymakers were struggling to come to a decision, have fueled expectations for a jumbo rate cut.

Read more: What the Fed rate decision means for bank accounts, CDs, loans, and credit cards

Outside of the Fed decision, investors will also be monitoring the health of the consumer, with retail sales for the month of August on the docket for Tuesday. The housing market will also be top of mind after mortgage rates dropped to their lowest level since February 2023.

A weekly update on jobless claims is also on the schedule, as well as activity checks from the manufacturing sector.

In corporate news, quarterly reports from FedEx (FDX), General Mills (GIS), Lennar Corporation (LEN), and Darden Restaurants (DRI) will headline the earnings calendar.

FedEx will be in particular focus, as earnings from the delivery conglomerate are often viewed as a bellwether for the state of the broader US economy.

The Fed's big decision

The Fed will announce its next monetary policy decision on Wednesday. Markets are largely split on whether the central bank will cut rates by 25 basis points to a range of 5% to 5.25% or by 50 basis points to a range of 4.75% to 5%.

Friday saw a significant jump in expectations for a 50 basis point cut, according to the CME FedWatch Tool. As of Friday afternoon, traders had placed a roughly 49% probability policymakers would commit to that larger rate cut, compared to just a 28% chance one day prior.

There's a case to be made for both. On the one hand, inflation has remained above the Federal Reserve's 2% target on an annual basis with hotter-than-expected readings on monthly "core" inflation suggesting the Fed should err on the side of caution and cut by just 25 basis points.

"With core inflation coming in higher than expected, the Fed’s path to a 50 basis point cut has become more complicated," Seema Shah, chief global strategist at Principal Asset Management, wrote following Wednesday's CPI report for the month of August.

Read more: Fed predictions for 2024: What experts say about the possibility of a rate cut

"The number is certainly not an obstacle to policy action next week, but the hawks on the committee will likely seize on [the] CPI report as evidence that the last mile of inflation needs to be handled with care and caution — a formidable reason to default to a 25 basis points reduction."

But other economic data points, including a jobs report that indicated a weakening labor market, suggest the central bank may already be behind the curve.

"We believe what the Fed should do next week is clear: recalibrate the policy rate 50bp lower to adjust for the shifting balance of risks," JPMorgan economist Michael Feroli wrote in a note to clients on Friday. "What the FOMC will do is less clear, but we’re sticking with our call that they will do the 'right' thing and cut 50bp."

Along with its policy announcement, the Fed will also release updated economic forecasts in its Summary of Economic Projections (SEP), including its "dot plot," which maps out policymakers' expectations for where interest rates could be headed in the future.

In June, Fed officials saw the fed funds rate peaking at 5.1% in 2024, suggesting just one 25 basis point cut to come this year. But the narrative has shifted quite considerably since that time. And with markets now pricing in 100 basis points' worth of cuts through the end of 2024, Wednesday's dot plot will show investors whether or not central bank leaders agree.

"Our baseline still assumes 25bp cuts at every other meeting, but the odds of a faster pace has increased given the Fed's goal to prevent more weakness in the labor market," Oxford Economics lead US economist Nancy Vanden Houten wrote on Friday.

Overall, stocks could turn volatile no matter which direction the Fed takes. That makes Fed Chair Jerome Powell's post-decision press conference all the more important.

"Powell’s task at 2:30 p.m. next Wednesday will very much depend on what the Committee chooses to do at 2:00 p.m.," Feroli said. "If it decides to cut 50bp, Powell will need to convey that the action is intended to support the outlook for sustained expansion in an environment of low inflation. If instead the FOMC opts for a 25bp cut he will need to indicate that the Fed stands ready to ease more aggressively on any sign of labor market softness."

Consumer check

A fresh reading on retail sales will also be closely tracked on Tuesday as investors wait to see whether or not July's robust rebound in sales can be sustained.

Economists expect that retail sales declined 0.2% in August from the prior month, which would mark a significant deceleration from the 1% sales growth surprise seen in July. Excluding gas and autos, expectations are for a 0.3% increase.

"The already-reported decline in vehicle sales will weigh on headline retail sales in August, but we anticipate a modest increase in core and control group sales, which will keep real consumption on track for a small gain in August," Oxford Economics' Vanden Houten said. "Real disposable incomes growth is proving resilient, and high-frequency indicators suggest consumer spending is continuing to steadily rise."

She added, "There are still no signs that weakening in the jobs market is feeding through to slower growth in consumer spending."

Weekly calendar

Monday

Economic data: Empire Manufacturing, September (-3.7 expected, -4.7 prior)

Earnings: No notable earnings

Tuesday:

Economic data: Retail sales, month over month, August (-0.2% expected, +1% previously); Retail sales ex-auto and gas, August (+0.3% expected, +0.4% previously); Industrial production, month over month, August (0.2% expected, -0.6% previously); Manufacturing (SIC) production, August (0.0% expected, -0.3% previously); NAHB Housing Market Index, September (41 expected, 39 previously)

Earnings: Ferguson Enterprises (FERG)

Wednesday

Economic data: Federal Reserve monetary policy decision (expected interest rate cut to range of 5.0% to 5.25% from range of 5.25% to 5.5%); MBA Mortgage Applications, week ending Sept. 13 (1.4% previously); Building permits month over month, August (+1.1% expected, -3.3% previously); Housing starts month over month, August (+5.8% expected, -6.8% previously)

Earnings: General Mills (GIS), Steelcase (SCS)

Thursday

Economic data: Initial jobless claims, week ending Sept. 14 (230,000 previously); Continuing claims, week ending Sept. 7 (1.85 million previously); Existing home sales month over month, August (-1.3% expected, 1.3% previously)

Earnings: FedEx (FDX), Lennar (LEN), Darden Restaurants (DRI), FactSet Research (FDS), Cracker Barrel (CBRL), Endava (DAVA), MillerKnoll (MLKN)

Friday

Economic data: No notable economic releases.

Earnings: Tamboran Resources Corporation (TBN)

Alexandra Canal is a Senior Reporter at Yahoo Finance. Follow her on X @allie_canal, LinkedIn, and email her at alexandra.canal@yahoofinance.com.

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