Citigroup and JPMorgan Chase & Co. are among firms making bold bets that the Federal Reserve will cut interest rates by 50 basis points this month, but that bet will face a test from the U.S. nonfarm payrolls report on Friday.

Interest rate swaps show that the probability of the Federal Reserve cutting interest rates by 50 basis points at its Sept. 17-18 meeting is about 35%, and traders still favor a 25 basis point cut, which is the more common call among economists.

The divergence exacerbated sharp swings in the Treasury market around the release of the nonfarm payrolls report, which sent markets into a tizzy after last month's weaker-than-expected jobs data.

“There’s a ton of uncertainty in the market that we expect to be resolved this week,” said Matthew Raskin, head of U.S. rates research at Deutsche Bank.

Fed Chairman Jerome Powell has put the labor market at the heart of the Fed’s decision on when and how quickly to ease monetary policy. Weak job openings data for July and weaker-than-expected ADP private sector payrolls growth earlier Thursday fueled expectations of aggressive rate cuts from the Fed.

The day after the jobs report, the Fed will enter its customary quiet period, during which it refrains from commenting on policy ahead of its meetings.

According to Deutsche Bank, over the past 15 years, at the start of the quiet period, there has typically been only a 3 basis point difference between expectations implied by swaps and the policy the Fed ultimately decides on. With markets currently pricing in about 34 basis points of easing, that means swaps will see a big move this week, either falling to at least 28 basis points or rising to 47 basis points or more - if the data clearly supports a 25 basis point or 50 basis point cut.

"There's a lot of uncertainty in the market about the jobs report, the stock market and what the Fed is going to do," said Alex Manzara, a derivatives broker at R.J. O'Brien & Associates. The S&P 500 has fallen more than 2% three times since late July.

Manzara said options pricing levels for U.S. two-year Treasury futures suggest that Treasury yields are expected to move about 17 basis points in either direction on Friday.

Meanwhile, pricing in overnight funding rate futures, an overnight rate that is influenced by the Fed’s policy rate, shows stronger confidence that the Fed will choose to cut rates by 50 basis points, said David Robin, interest rate strategist at TJM Institutional Services LLC.

In addition, foreign exchange traders were more active ahead of the release of the U.S. jobs report than they were more than a year ago. Options that measure the volatility of the dollar against major traded currencies reached their highest level since March 2023 on the eve of the release of the key non-farm payrolls data. So-called risk reversals showed bearish sentiment on the dollar, while some traders were avoiding short-term bets altogether because of the uncertainty.

The agency pointed out that "Friday's non-farm payrolls report is so important to the market, in part because the bond market tends to expect the Fed to either cut interest rates by 50 basis points to start the upcoming easing cycle or to cut interest rates shortly after the easing cycle begins. Looking back at the history of the Fed's interest rate cuts, it can be found that bond bulls may be over-chasing."

Citigroup and JPMorgan Chase have been expecting the Fed to cut interest rates by 50 basis points in September and November and 25 basis points in December since the weaker-than-expected July jobs data released on July 2. At the time, JPMorgan economists even said that the Fed had a strong case for action before September 18, which would be the first inter-meeting rate cut by the Fed since March 2020.

The market agreed with their view, pricing in nearly 125 basis points of Fed rate cuts by the end of the year, reflecting a broad sell-off. But then, market expectations for Fed rate cuts this year fell as retail sales were strong and jobless claims fell. Swap markets now price in about 110 basis points of Fed rate cuts this year -- a figure that still suggests the Fed will cut by 50 basis points at least once.

Citigroup and JPMorgan Chase & Co. recently moderated their views but did not change their forecasts. Citigroup said the Fed would likely cut rates by only 25 basis points if the U.S. unemployment rate fell to 4.2% from 4.3% in August, "unless wage growth is also weak." JPMorgan Chase & Co. said a 50 basis point rate cut "would depend somewhat on the August jobs report."

Raskin pointed out that if the employment data fails to lock in a 25 basis point or 50 basis point rate cut by the Federal Reserve in September, the August CPI data released on September 11 may still provide guidance. But if this fails to move the market, then policymakers may break their silence and hint at what actions they intend to take. He added:

“The Fed doesn’t like to surprise the market at its policy meetings.”

The article is forwarded from: Jinshi Data