The Fed is expected to prevent a recession by making significant interest rate reductions, as markets are closely monitoring their actions.

• The Fed is viewed by the market as being either prepared to prevent a recession or doomed to repeat its past errors.
• If the Fed does not act, a recession is likely to occur by the end of the year, according to Steve Blitz, the chief U.S. economist at TS Lombard.
• The Fed's short-term borrowing rate could decrease by 2.25 percentage points by the end of next year, with traders anticipating a half-point September cut and subsequent aggressive easing.

The Federal Reserve is either on the brink of preventing a recession or doomed to repeat its past mistakes, as it failed to recognize the impending storm.

The response of Chair Jerome Powell and the central bank will significantly impact how investors navigate the current volatile market. Over the past few days, Wall Street has experienced significant fluctuations, with a relief rally on Tuesday helping to mitigate some of the damage caused by intensified recession concerns last week.

"According to Steven Blitz, chief U.S. economist at TS Lombard, a recession is increasingly inevitable by year-end if the Fed does not act. However, they will begin with a half percentage point cut in September, which was telegraphed in late August."

Wall Street's general consensus, as expressed by Blitz, is that a recession is unlikely unless the Fed takes inaction. In that case, the likelihood increases.

Recent economic data has caused concern that the Fed may have missed an opportunity to ease monetary policy at its meeting last week. This recalls memories of the 2021 inflation surge, which was initially dismissed as "transitory" by Fed officials, leading to a series of harsh rate hikes.

The Fed must act strongly to prevent a recession, as the weak jobs report from July has intensified concerns about an economic downturn.

The likelihood of a half-point September cut and aggressive easing that could reduce the Fed's short-term borrowing rate by 2.25 percentage points by the end of next year is reflected in 30-day fed funds futures contracts. The Fed's current key rate target is between 5.25%-5.5%.

"According to Citigroup economist Andrew Hollenhorst, the rise in the unemployment rate is a clear indication that the US economy is at risk of falling into a recession. Data over the next month is likely to confirm the continued slowdown, keeping a half-point cut in September likely and a potential intermeeting cut on the table."

Emergency cut unlikely

It is unlikely that an emergency cut in interest rates will occur between now and the Sept. 17-18 open market committee meeting, given the strong job creation and near-record stock market averages, even after a recent sell-off.

The depth of recession fears is evident from the fact that it is being discussed, as the Fed has only implemented nine such cuts in the past, all during times of extreme stress, according to Bank of America.

According to BofA economist Michael Gapen, if the question is whether the Fed should consider an intermeeting cut now, history suggests the answer is "no, not even close."

Despite the absence of a catalyst for an intermeeting cut, the Fed is expected to cut rates almost as quickly as it hiked from March 2022 to July 2023. Powell is expected to signal the easing path during his keynote policy speech at the Fed's annual retreat in Jackson Hole, Wyoming, which could start later this month.

By the end of 2025, Joseph LaVorgna, the chief U.S. economist at SMBC Nikko Securities, anticipates that the Fed will reduce interest rates by a more significant margin of 3 full percentage points, in contrast to the current market forecast.

"Why wait for the Fed to remove the tightness when rates aren't at the right level? They'll be quick in cutting if for no other reason than rates are too high."

LaVorgna believes that the Fed is not facing a life-or-death battle against recession. Nevertheless, he emphasizes that normalizing the inverted yield curve, which involves getting longer-dated securities to yield more than their shorter-dated counterparts, will be crucial in preventing an economic contraction.

Goldman Sachs raised its recession forecast from 15% to 25% over the weekend, but the bank believes that a recession is not imminent due to the Fed's ability to cut interest rates by 5.25 percentage points and restart its quantitative easing program.

Any unexpected quakes in the data, such as Friday's downside surprise to the nonfarm payrolls numbers, could quickly spark recession talk.

"David Rosenberg, founder of Rosenberg Research, wrote Tuesday that the Fed is currently as behind the economic curve as it was behind the inflation curve in 2021-2022. He added that the expectation for cuts is reminiscent of a true recession scenario because the Fed has rarely done this without an official economic downturn."