Investors sharply increased bets the Federal Reserve will cut interest rates by 50 basis points next week as it prepares to lower them for the first time in more than four years.

Traders in the swaps market are pricing in a 45 percent chance that the Fed will slash interest rates at its September meeting to prevent higher rates from hurting the economy, compared with a 15 percent chance on Thursday.

Changes in traders' expectations for the size of the Fed's rate cut next week

Mark Dowding, chief investment officer of BlueBay Asset Management, a top global asset management company under Royal Bank of Canada, said that the possibility of a 50 basis point rate cut is now "very high", while this expectation was "almost completely ruled out" on Thursday. The market still believes that there is a 55% chance of a small 25 basis point rate cut, but it has cooled significantly compared with Thursday.

On Thursday evening, the Financial Times and the Wall Street Journal reported that the Fed faced a difficult decision of whether to cut interest rates by 50 basis points or 25 basis points. Bill Dudley, former president of the New York Fed, also wrote that he believed there was a "strong case" 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 23-year high) on growth.

The Fed typically adjusts interest rates in 25 basis point increments, but a 50 basis point cut could be used as a preemptive measure if officials believe the economy is at risk of slowing too quickly.

Minutes from previous meetings showed some officials thought it was “reasonable” for the Fed to cut interest rates at its last meeting in July, suggesting that larger rate cuts could help the Fed catch up as inflation has fallen further since then.

“The least regrettable course of action for the Fed would be to be the first to raise rates by 50 basis points,” said Tim Duy, chief U.S. economist at SGH Macro Advisors. “It’s the only logical policy choice.”

Next Wednesday’s Fed meeting, the last for Harris and Trump before the November presidential election, is fraught with high tensions as officials try to steer the world’s largest economy to a “soft landing” — one in which inflation is contained without triggering a recession.

Analysts say the meeting is one of the most uncertain in years as recent data shows a mixed picture for the U.S. economy, with price pressures remaining and the labor market softening.

This week's CPI data showed that overall inflation fell to 2.5%, close to the Fed's 2% target, but core inflation rose 0.3% month-on-month, higher than expected, partly due to pressure in the housing market.

“If inflation in the housing sector remains, a 50 basis point rate cut could actually accelerate or amplify that,” said Wylie Tollette, chief investment officer at Franklin Templeton Investment Solutions, who expects the Fed to cut rates by 25 basis points next week, adding that the election could also complicate the prospect of a larger rate cut.

Trump has previously said that the Federal Reserve's rate cuts would help Harris, who is now vice president, "even though they know they shouldn't do that."

“The path of the Fed is that they want to do what’s right for the economy, and I don’t think they want to be seen as favoring the incumbent candidate by cutting rates more aggressively,” Tollette said.

But with unemployment rising and demand slowing, Fed officials want to prevent further weakness in the labor market. Fed Chairman Jerome Powell said last month the central bank will do “whatever it takes to support the labor market as we make progress toward price stability.”

“It’s a cat-and-mouse game,” said Salman Ahmed, global head of macro at Fidelity International. “We’re about to start a rate-cutting cycle, but a lot of it is still to be determined.” For much of the post-COVID-19 cycle, “it was clear that neither the market nor the Fed knew what was going to be done,” he added.

In December, the Fed forecast a 75 basis point rate cut in 2024, but by June it said it would cut rates by just 25 basis points this year.

Article forwarded from: Jinshi Data