Traders are betting on a big Fed rate cut

Traders on Tuesday maintained bets that the Federal Reserve will begin a long-awaited round of interest rate cuts on Wednesday with a half-percentage point move lower, an expectation that may put pressure on central bankers to do just that.

Futures tied to the Federal Reserve’s policy rate midmorning Tuesday implied a two-in-three chance of a larger cut, versus a one-in-three chance of a more moderate 25-basis-point reduction that analysts at most major Wall Street firms continued to expect.

The Federal Reserve begins its two-day meeting today to set its monetary policy, and will meet again in early November and mid-December.

Traders expect a total of two half-percentage point rate cuts plus one quarter-point cut over the remaining three meetings in 2024, according to interest rate futures.

The Federal Reserve has been keeping the official interest rate between 5.25% and 5.50% for over a year in order to curb high inflation.

Inflation has fallen to 2.5% and is seen by most policymakers as well on track toward the Federal Reserve’s 2% target. At the same time, the unemployment rate rose to 4.2% last month. Almost all Fed policymakers agreed even in July that the time would soon come to start cutting rates to prevent the economy from slowing too much.

Until late last week, traders were betting on a quarter-percentage point rate cut to start the series, but are now leaning toward a half-point cut after articles in the Wall Street Journal and Financial Times on Thursday suggested a bigger reduction remained an option.

Market expectations have only firmed since then, and were barely budged on Tuesday when government reports showed U.S. retail sales unexpectedly rose in August and the manufacturing sector rebounded, signs the economy still has steam.

Still, analysts have speculated that last week’s news may have been based, at least in part, on central bank guidance. The Fed’s apparent lack of response since then has only served to reinforce the assumptions.

“As time passes without any apparent effort from the Fed to counter market pricing, which has raised the odds of a 50 basis point cut at the September Federal Open Market Committee meeting, we confirm our belief that the Fed is likely to cut 50 basis points, although this is still not a sure thing,” wrote Krishna Guha of Evercore ISI, who is among the minority of economists who have argued for a deeper rate cut even before last week’s shift in financial market expectations.

Now that markets are heavily tilted toward further monetary policy easing, he wrote, “it is much harder to surprise with a hawkish line than with an easy one, and there is no way the Fed thinks this is a good time to introduce more (volatility).”

Guha predicted that a half-point rate cut might provoke one or two disagreements within the Fed, but so might a smaller quarter-point cut.

By mutual agreement, Federal Reserve policymakers do not make public statements about monetary policy or the economy during the 10 days before a meeting.

“We believe the Fed is attempting to course-correct at an unfortunate time,” wrote Tim Duy of SGH Macro Advisors. “The blackout period prevents conventional communications, and the Fed becomes somewhat more clumsy.”

Connect with the Voice of America! Subscribe to our channelsYouTube, WhatsApp and to newsletter. Turn on notifications and follow us on Facebook, X and Instagram.