The Dow Jones Industrial Average was nearing an all-time high as expectations of a big interest rate cut by the Federal Reserve next week suddenly rekindled.
Stock and bond traders on Friday grew increasingly believing the Fed could cut interest rates by 50 basis points (half a percentage point) after The Wall Street Journal reported that the central bank is increasingly focused on the health of the U.S. job market over inflation.
The Dow Jones Industrial Average recently rose 287 points to 41,384, not far from its Aug. 30 record high of 41,563.
Swaps market traders had effectively ruled out a 50 basis point cut earlier this week, but more recently put the chances of Fed officials opting for a bigger cut at next week's policy meeting at 47%.
Still, it is expected to be the first rate cut since 2020, with a slight majority (53%) predicting a more general cut of 25 basis points from the central bank's current key lending rate of 5.25% to 5.5%.
“Several articles in the Wall Street Journal and Financial Times suggesting a 50 basis point rate hike is still feasible has once again caused the market to reassess expectations,” Deutsche Bank analysts said in a client note.
Former Federal Reserve Chairman Bill Dudley said at a forum in Singapore on Friday that there was a “strong case” for a big rate cut.
“I know what I'm going to push for,” said Dudley, who led the New York Fed until 2018. “The question is, why not start now? It's essentially up to Chairman Powell to decide how much support there is for more aggressive policy.”
Bob Savage, head of market strategy at BNY Mellon, said investors want the Fed to “ease quickly and continue to combat the risks of a recession.”
The planned cuts reportedly come after weaker-than-expected labour market figures for August showed 142,000 jobs were created.
“The time has come to adjust policy,” Fed Chairman Jerome Powell said last month in a keynote speech at the Fed's annual economic conference in Jackson Hole, Wyo. “The direction to move is clear, and the timing and pace of rate cuts will depend on upcoming data, the evolving outlook, and the balance of risks.”
Lower interest rates would lower borrowing costs for American households by making credit card and mortgage payments cheaper.
That could encourage consumer spending and business investment, giving the U.S. economy a boost with less than two months to go until the election amid fears of a recession.
Inflation — the rise in prices of major goods — has appeared to be kept in check in recent months by the Federal Reserve, which has kept interest rates unchanged for the past 14 months.
Consumer prices rose 2.5% in August ahead of the November presidential election, with the cost of living expected to be one of the main issues as Americans head to the polls.
This is down from the most recent peak of 9.1% in June 2022, when governments around the world were dealing with the impact of the COVID-19 pandemic.
“The inflation data is good enough for the Fed to start cutting rates in September, but it does not warrant aggressive rate cuts,” Brian Rose, senior U.S. economist at UBS, wrote in a note.
“If the Fed hikes rates by 25 basis points instead of 50 basis points, investors would have to rethink their optimism about a cyclical recovery or no recession,” said Arnim Holzer, global macro strategist at Easterly EAB Risk Solutions.
The Fed will join a global cycle of rate cuts after the European Central Bank, which sets interest rates for the 20 euro zone countries, announced its second rate cut in three months on Thursday.
ECB officials in Frankfurt, Germany, pointed to slowing inflation and faster economic growth as reasons for the rate cut.
