The latest data shows Wall Street investors are betting the Federal Reserve is more likely to opt for a bigger interest rate cut than a quarter-point reduction.
Futures markets for the federal funds rate, which measures the cost of unsecured overnight lending between banks, are pricing in a 61% chance that the central bank will cut rates by 50 basis points on Wednesday.
That's up from 45% at the time of last Friday's big rate cut, and up from just 25% just days ago when the latest Consumer Price Index report showed weaker-than-expected inflation data.
The Fed holds a two-day policy meeting starting on Tuesday and is widely expected to cut its benchmark overnight interest rate, which is currently in the range of 5.25% to 5.50%.
However, over the past few days, rate cuts have been a coin toss between 50bps and 25bps.
Until last Friday, a half-point cut seemed unlikely: On Sept. 9, the probability of a quarter-point cut was 70%, while the probability of a half-point cut was just 30%, according to CME FedWatch.
Core CPI data and the core wholesale price index – two inflation measures that exclude volatile food and energy prices – released last week came in better than expected, further weakening hopes for a half-point cut.
But traders on Friday strengthened their expectation that the Fed would cut rates by half a percentage point after The Wall Street Journal reported that bankers were shifting their focus from inflation to the job market and former New York Fed President Bill Dudley argued for a half-point cut.
in Bloomberg Opinion ArticleDudley said that as the Fed's focus on price stability and maximum employment has become more stable, monetary policy should be neutral and not overly corrective.
“However, short-term interest rates remain well above neutral levels. This disparity needs to be corrected as soon as possible,” Dudley wrote.
The size of the Fed's rate cut “isn't so important given the long time lag and transmission mechanisms, but it is important in terms of how the Fed wants to be perceived,” said Boris Kovacevic, global macro strategist at Combera in Vienna.
“If the rate hike reaches 50 percent, the Fed may have information investors don't have and the risk of a recession may be higher than currently expected or priced in,” Kovacevich said.
The Fed's aggressive rate hikes in 2022 and 2023 following the pandemic have suppressed demand, stagnating hiring and contributing to a slowdown in the labor market.
Economists had expected the U.S. economy to fall into recession after a series of rate hikes, but easing inflation has raised hopes that the Fed can achieve a soft landing.
With post wire
