A look at the day ahead in U.S. and global markets from Mike

Dolan

There's little left to say about the dominant event of the day -

other than how to game markets' reaction to the size of the

Federal Reserve's interest rate cut later and what Fed

policymakers project over the horizon.

Few, if any, doubt the first Fed easing of the cycle is now

at hand. Wall Street's S&P500 hit a new intra-day record

on Tuesday ahead of the decision - lapping up the prospect of

lower borrowing costs even as the economy picks up some steam.

Stock futures held firm overnight into the big decision.

What's not to like?

A last-minute economic health-check as Fed officials

gathered showed retail sales unexpectedly rising again in August

and factory output beating forecasts, confounding more downbeat

surveys of manufacturers last month.

So much so, the Atlanta Fed's 'GDPNow' model raised its

third-quarter growth estimate by half a point to 3% afterwards -

on par with the pace the economy grew in the second quarter.

And despite the effervescence in markets and buoyancy of the

economy, futures are still leaning toward a 50 basis point Fed

cut on Wednesday rather than a more regular 25bp move. With 40bp

still priced, that puts the chances of a bigger move at 60%.

Former Fed economist Claudia Sahm was on Tuesday the latest

Fed alumnus to call for the heftier 50bp cut this week - arguing

now was the time to act to prevent unnecessary job losses and

ensure the central bank's twin goals were met.

"This is a Fed that has been very much behind the

maximum-employment side of the dual mandate," Sahm said.

So, on the face of it, the economy in humming with a big

rate cut coming and inflation is back in its box. Those poring

over market almanacs see only good things from that.

It may be different this time, of course, but the average

one-year stock market return after the first Fed rate cut is

almost 5% even when a recession occurs. And it's more than 16%

when the cuts come without a recession materialising at all -

the most likely scenario now facing investors.

On the other hand, would the stock and bond markets now sulk

if they don't get the 50bp cut favoured in the futures market?

For that, we may need to see how the cut matches up with Fed

policymakers' 'dot plot' of future rate projections. Markets may

quickly brush off a move if it simply pushes the total amount of

easing out to coming meetings and expresses confidence about the

economy.

Some think signs of dissent in the 'dot plot' may be

important - not least if it suggests the Fed eased less than

some of its policymakers thought it should.

And of course there will be attention on the so-called long

term dot, which was put most recently at 2.8%. As this is

broadly seen as Fed officials' estimate of the sustainable

'neutral' rate that neither spurs nor slows the economy, it's

important in calculating Fed thinking on the extent of the

cycle.

Before we get there, the Treasury market has sobered up a

bit - with the two-year yield edging back above 3.60%

- more than 10bps above two-year lows hit on Monday. That's been

just about enough to hold the dollar index off the year's

low for now and above 141 Japanese yen.

The yen was reined in further by disappointing Japanese

trade data that saw both exports and imports miss forecasts.

Stocks around the world generally mixed to positive, in line

with Wall Street futures.

Underperforming in Europe, UK stocks lost some

ground and the pound pushed above $1.32 as the Bank of

England is not expected to follow the Fed on Thursday - likely

leaving its second cut of the year until after the new Labour

government's first budget next month.

Reinforcing that thinking, British inflation held steady in

August but sped up in the services sector which is closely

watched by the BoE. Even though headline inflation remained

steady near target at 2.2%, services inflation climbed above

forecast to 5.6%.

But as much attention on Thursday may be on the BoE's latest

annual estimate for the rundown of its balance sheet of bonds -

widely expected to be a targeted 100 billion pound reduction

over the next 12 months, as it was last year. A potential boom

for the bond market, however, is that repeating that target

would mean a 75% reduction in active gilt sales due to a large

schedule of maturing debt that would runoff automatically.

Canada on Tuesday had much better news on the inflation

front, with its CPI rate hitting the central bank's 2% target in

August - below forecast and fuelling hopes for a 50bp rate cut

from the Bank of Canada next month.

Key developments that should provide more direction to U.S.

markets later on Wednesday:

* Federal Reserve's Federal Open Market Committee announces

policy decision, with quarterly economic projections and press

conference by Fed chair Jerome Powell

* US August housing starts/permits, July TIC data on overseas

Treasury holdings

* Brazil central bank policy decision

* International Monetary Fund First Deputy Managing Director

Gita Gopinath speaks in Ireland

* US corp earnings: General Mills

(By Mike Dolan, editing by Andrew Cawthorne

[email protected])