Stay informed with free updates
Simply sign up to the US interest rates myFT Digest — delivered directly to your inbox.
Investors have significantly increased their speculation on a potential half-percentage-point interest rate cut by the Federal Reserve (Fed) in the upcoming week, marking a potential reduction in borrowing costs for the first time in more than four years.
Currently, traders in the swaps markets are pricing in a 49 percent chance that the Fed will proceed with a larger cut to prevent high rates from impacting the economy. This is a notable increase from the 15 percent chance priced in on the previous Thursday.
This reassessment contributed to a rise in stocks on Friday, leading to the S&P 500 and the Nasdaq Composite achieving their most significant weekly gains this year, with increases of 4 percent and 6 percent, respectively.
Mark Dowding, Chief Investment Officer at RBC BlueBay Asset Management, noted that a half-point cut was now “very much in play” after having been “almost entirely priced out” earlier.
Although markets still attribute a 51 percent probability to a smaller quarter-point cut, this likelihood has decreased considerably since Thursday.
On Thursday evening, Financial Times and the Wall Street Journal indicated that the Fed faces a close decision between opting for a half-point or a quarter-point cut.
Former New York Fed President Bill Dudley expressed on Friday that there is a “strong case” for a half-percentage point cut, citing the restrictive impact of the current rate of 5.25 to 5.5 percent, the highest in 23 years, on economic growth.
The Fed typically makes adjustments in quarter-point increments, but a 0.5 percentage point cut could act as a precautionary measure if officials believe the economy is at risk of decelerating too rapidly.
Some Fed officials had considered it “plausible” to lower rates at the previous July meeting, according to the minutes from that meeting, suggesting that a larger cut might help the central bank catch up as inflation has decreased further since then.
Tim Duy, Chief U.S. Economist at SGH Macro Advisors, remarked that the “path of least regrets for the Fed is to lead with 50 [basis points],” considering it the only logical policy choice.
Gabriele Foà, a fund manager at Algebris Investments, stated that the Fed would be better off frontloading cuts instead of risking “falling behind the curve in a downturn.”
Wednesday’s Fed meeting is the last before November’s presidential election between Kamala Harris and Donald Trump, adding an extra layer of complexity as officials aim to guide the U.S. economy toward a “soft landing” where inflation is reduced without causing a recession.
A survey from the University of Michigan indicated that consumer expectations for inflation over the next year have fallen to 2.7 percent, the lowest since late 2020. Additionally, September’s consumer sentiment rose to a four-month high, according to the university’s report on Friday.
The yield on two-year U.S. Treasury bonds, which reflects interest rate expectations and moves inversely to prices, decreased by 0.06 percentage points to 3.59 percent on Friday.
Analysts have described the upcoming meeting as one of the most uncertain in recent years, due to mixed economic data showing both persistent price pressures and weakness in the labor market.
Recent figures showed a decline in headline inflation to 2.5 percent, close to the Fed’s target of 2 percent, but core inflation rose by 0.3 percent month-on-month, driven in part by housing market pressures.
Wylie Tollette, Chief Investment Officer at Franklin Templeton Investment Solutions, opined that a 50 basis point cut could potentially exacerbate lingering inflation in the housing sector, suggesting a quarter-point cut might be more appropriate. He also highlighted that the upcoming election could complicate the case for a significant rate cut.
Donald Trump has suggested that a Fed rate cut would benefit Kamala Harris, the incumbent Vice President, although Tollette believes the Fed aims to make decisions in the best interest of the economy without appearing politically motivated.
However, with rising unemployment and slowing demand, Fed officials are intent on preventing further weakening of the labor market. Fed Chair Jay Powell stated last month that the central bank would “do everything we can to support a strong labor market as we make further progress towards price stability.”
Salman Ahmed, Global Head of Macro at Fidelity International, described the situation as a “cat-and-mouse game,” noting that while the rate-cutting cycle has begun, many aspects remain undetermined. He added that neither the market nor the Fed seem fully aware of the Fed’s future actions.
Last December, the Fed had forecasted 0.75 percentage points of cuts for 2024, but by June, it anticipated only one quarter-point cut for the year.
Additional reporting by Kate Duguid and Laurence Fletcher
