The probability of the Fed cutting interest rates by 25 or 50 basis points next week is close to fifty-fifty, making this the most uncertain meeting in years.
As the Federal Reserve prepares for its first interest rate cut in over four years, investors have significantly increased their bets on a 50 basis point rate cut next week.
Traders in the swaps market are currently pricing in a 45% chance of a significant rate cut by the Federal Reserve at the September meeting to prevent damage to the economy from high interest rates. In contrast, this probability was only 15% on Thursday.
Mark Dowding, Chief Investment Officer of BlueBay Asset Management, a top global asset management firm under the Royal Bank of Canada, said the likelihood of a 50 basis point rate cut is now "very high", whereas on Thursday this expectation was "almost completely ruled out". The market still believes there is a 55% chance of a small 25 basis point rate cut, but the probability has significantly cooled compared to Thursday.
On Thursday evening, both the Financial Times and the Wall Street Journal reported that the Federal Reserve faces a difficult choice between a 50 basis point or a 25 basis point rate cut. Former President of the New York Fed, Bill Dudley, also wrote afterwards that he believes there are "strong reasons" for a 50 basis point rate cut next week and emphasized the restrictive impact of the current policy rate of 5.25% to 5.5% (a new high for 23 years) on growth.
The Federal Reserve typically adjusts interest rates by 25 basis points, but if officials believe there is a risk of the economy slowing too quickly, a 50 basis point rate cut can be seen as a preemptive measure.
Previous meeting minutes show that some officials believe that the Fed's rate cut in July was "reasonable," indicating that with further decline in inflation afterwards, a larger rate cut may help the Fed catch up.
SGH Macro Advisors Chief US Economist Tim Duy stated: "For the Fed, the least regrettable approach would be to raise rates by 50 basis points. This is the only logical policy choice."
Next Wednesday's Fed meeting is the last one before the November presidential election for Harris and Trump, with officials attempting to guide the world's largest economy towards a "soft landing" while faced with high pressure. A 'soft landing' refers to curbing inflation without triggering an economic recession.
Analysts suggest that this meeting is one of the most uncertain in years, as recent data shows a mixed picture of the US economy, with lingering price pressures and some softness in the labor market.
This week's CPI data shows that the overall inflation rate has dropped to 2.5%, close to the Fed's 2% target, but the core inflation rate rose 0.3% from the previous month, higher than expected, partly due to pressure from the real estate market.
Wylie Tollette, Chief Investment Officer of Franklin Templeton Investment Solutions, believes, "If inflation in the housing industry persists, a 50 basis point rate cut might actually accelerate or amplify the situation." He expects the Fed to cut rates by 25 basis points next week, and adds that the election may complicate the prospect of a large rate cut.
Trump has previously stated that a Fed rate cut would help Harris become the current vice president, "even though they know they shouldn't do that."
Tollette stated: "The Fed's path is they want to do the right thing for the economy, and I don't think they want to be seen as favoring the incumbent candidate by making more aggressive rate cuts."
However, as the unemployment rate rises and demand slows down, Federal Reserve officials hope to prevent further weakness in the labor market. Federal Reserve Chairman Powell said last month that he will "make every effort to support the labor market when there is progress in price stability".
Salman Ahmed, Global Head of Macro at Fidelity International, said, "This is a game of cat and mouse. We are about to start an interest rate cutting cycle, but much remains to be determined." He added that for most of the time after the COVID-19 pandemic, "it is clear that neither the market nor the Federal Reserve knows what to do."
In December last year, the Federal Reserve predicted a 75-basis-point rate cut in 2024, but by June, it said it would only cut rates by 25 basis points this year.
Editor/Lambor