Traders have re-introduced their expectations for a Federal Reserve interest rate cut, lifting U.S. government bond prices and adding to uncertainty over next week’s decision. After the market had discounted the possibility, expectations for a 50 basis point cut rose to around 44%. The increase came after a report from the Wall Street Journal, which indicated that policymakers were undecided between a quarter-point or half-point cut.
Financial markets have been debating the size of the first rate cut of this cycle for weeks. Although inflation and labor market data have stabilized, speculation of a larger cut has not completely faded, which could lead to volatility ahead of the Sept. 18 meeting. Analysts at Deutsche Bank, including Henry Allen, said: “If expectations remain as they are, this will be the first meeting in years where uncertainty about the rate decision is present.” The two-year yield fell five basis points to 3.59%, while the 10-year yield fell three basis points to 3.65%. The dollar also weakened, supporting major currencies.
The case for a rate cut has been growing over time, as the central bank’s preferred inflation rate has eased toward its 2% target from above 7% two years ago. Disappointing US data, such as an unexpected drop in jobs, has also bolstered calls for monetary policy easing.
Investors are awaiting preliminary US consumer sentiment data due today for further clues on the outlook for interest rates. Prashant Nyonya, chief interest rate strategist at NYSE: …
Markets Expectations for Potential Rate Changes
On the other hand, the CEO of Investments stated that the Federal Reserve may start with a gradual 25 basis point cut, as the economy appears to be doing well. Our Federal Funds Rate Tracker is based on the 30-day Federal Funds futures, which typically indicate market expectations for potential changes in US interest rates based on the Fed’s monetary policy. This tool allows you to calculate the probability of a Fed rate hike in the near term.
The Consumer Price Index (CPI) report released on Wednesday showed that core prices rose by 0.3% in August, exceeding experts’ expectations of a 0.2% increase. This negative inflation news could shift the focus away from the labor market, increasing the likelihood that the Federal Reserve will adopt a more dovish approach, starting with a 25 basis point cut next week.
A 50 basis point rate cut could send a pessimistic signal about the health of the US economy, which could be interpreted as a panic move and indicate that the Fed lacks control. Since 1990, the start of a 50-basis-point rate-cut cycle (in 2001 and 2007) has been associated with a recession. The first 25-basis-point cut is best associated with a policy adjustment, while a 50-basis-point cut could signal the Fed is too late to avoid a recession.
As of Wednesday morning, markets were expecting a total of 100 basis-point cuts this year. More clues about the Fed’s thinking will come on Sept. 18 when it releases its Summary of Economic Projections, including a “dot plot” that outlines policymakers’ expectations for future interest rates.
The Fed’s outlook for this year is lower than the market had anticipated
If the Fed’s expected total cuts this year are less than the market expects, that’s not necessarily a negative for stocks. If you exclude cuts due to stronger-than-expected growth, such as strong third-quarter GDP growth, improving labor market indicators, and continued strong consumer spending, stocks may find more room to grow as earnings continue to strengthen.
Forget the U.S. recession; for now, China’s slowdown is weighing on oil prices, global bond yields, and the dollar. Weak Chinese oil demand prompted OPEC to cut its global oil demand forecast today. That sent Brent crude prices below $70 a barrel on Tuesday, their lowest since December 2021. The debate over the size of the first cut of this cycle has gripped markets for weeks. While solid inflation and labor market data support a gradual cut, speculation of a larger cut has not gone away, creating a sense of anticipation ahead of the Sept. 18 meeting.
The 2-year yield fell 5 basis points to 3.59%, and the 10-year yield fell 3 basis points to 3.65%. The dollar also fell, supporting major currencies. However, the Fed may not cut by more than 25 basis points unless recessionary conditions or a financial crisis emerge. Those calling for a 50 basis point cut should reconsider the potential volatility in the markets, as this is not something the Fed wants to risk. Despite signs of a slowdown in the labor market from the recent jobs report, the data overall did not reveal the deep recession that some believe is needed to trigger a deeper cut. The risk is that a deteriorating labor market could signal a recession.
