3 scenarios for the Fed rate decision — and how markets could react to each

Investors widely expect the Federal Reserve to implement a 25 basis point rate cut this week, with JPMorgan assigning an 87.5% probability. JPMorgan's most likely scenario (47.5% chance) is a "dovish cut," which could initially boost the S&P 500 by 1% but potentially lead to a 5% "sell-the-news" decline by month-end due to various macroeconomic headwinds and market positioning. A "hawkish cut" (40% chance) is the next most likely outcome, potentially causing the S&P 500 to remain flat or drop by 0.5%. Should a sell-off materialize, JPMorgan suggests buying opportunities in tech, utilities, healthcare, and biotech stocks.

Analysis

The market is positioned for a near-certain Federal Reserve rate cut this week, pricing in a 96.2% probability of a 25 basis point reduction. JPMorgan's analysis aligns with this, forecasting an 87.5% chance of a quarter-point cut and outlining a nuanced set of potential market reactions. The most likely scenario, with a 47.5% probability, is a "dovish cut," which could initially propel the S&P 500 up by approximately 1%. However, JPMorgan cautions this could be followed by a "sell-the-news" event, potentially leading to a 5% market decline by month-end due to headwinds such as stretched positioning, waning retail participation, and quarter-end rebalancing. The second most probable outcome (40% chance) is a "hawkish cut," where a 25 bp reduction is coupled with cautious commentary, potentially causing the S&P 500 to trade flat or fall by 0.5%. Less likely scenarios include holding rates steady (4% probability, 1-2% S&P 500 drop) or a 50 bp cut (7.5% probability, +/- 1.5% swing), the interpretation of which would depend on whether the market views it as proactive or reactive to a weakening labor market. The expected volatility is high, with S&P 500 options pricing in an 88 basis point move on the day of the announcement.

Key Decisions for Investors

• Given the high probability of a 'sell-the-news' reaction even in the most favorable outcome, investors should be cautious of chasing an initial rally and prepare for a potential near-term S&P 500 pullback of up to 5%.
• It is critical to monitor the Fed's commentary closely, as a 'hawkish cut' is assigned a significant 40% probability and could trigger a negative market reaction, nullifying bullish sentiment.
• Investors should consider a potential post-announcement sell-off as a strategic buying opportunity, preparing to increase exposure to sectors like mega-cap tech, AI, utilities, healthcare, and biotech, as suggested by JPMorgan.
• With options markets pricing in an 88 basis point move, portfolio managers should review their positions for resilience against heightened volatility on the day of the Fed's decision.