Expectations for a Big Rate Cut Rise Ahead of Fed Meeting

Traders over the weekend raised their bets the Federal Reserve would cut interest rates substantially as market participants looked forward to what’s expected to be the most consequential Fed meeting in years.

Market Pricing

Markets on Monday morning were pricing in a roughly 60% chance the Fed would cut its benchmark federal funds rate by 50 basis points (bps) when it concludes its two-day policy meeting on Wednesday. That was up from 50% on Sunday and as low as 15% last week, when consumer inflation data reminded investors that prices continue to rise faster than the Fed’s target rate of 2% annually.

Debate on Rate Cut Size

Investors and Fed watchers have been debating the size of the central bank’s impending rate cut ever since Chair Jerome Powell in August effectively confirmed that it was ready to begin loosening monetary policy after holding rates at a two-decade high for more than a year.

Signs of a softening labor market have led some, including former New York Fed President Bill Dudley, to advocate for a 50-basis-point cut. A pivot of that magnitude would be somewhat of a rarity outside of economic crisis. Others have urged caution, highlighting the labor market’s peculiar strength over the last few years and the inflationary risks of pivoting too quickly.

Analysts Weigh in on Size of Rate Cut

Analysts on Monday were split on the likelihood of a big cut. Bank of America analysts wrote in a note that they expected a more traditional 25-bps cut. “Fed officials did not signal a larger cut prior to the blackout period & since then US inflation data has printed slightly firm,” they wrote. Bob Schwarz, Senior Economist at Oxford Economics, concurred. “The case for a traditional quarter-percent pivot is not only likely but justified by emerging conditions,” he wrote, referring to last week’s hotter-than-expected inflation report and signs of the labor market’s resilience.

Deutsche Bank analyst Jim Reid, on the other hand, pointed out in a note that the Fed probably wants to avoid surprising markets with its rate cut on Wednesday. Rising expectations for a 50-point cut, then, could help nudge officials into a more aggressive cut than had been forecast.

Markets’ Track Record

While the Fed has avoided surprising Wall Street with its rate decisions over the last few years, market participants have also been less-than-stellar predictors of Fed policy over the long term.

At the beginning of the year, Wall Street was expecting the Fed to cut rates aggressively, starting as early as March. But those bets didn’t pan out when inflation proved stickier than expected.

The estimated date of the Fed’s first rate cut has been steadily pushed back throughout the year as data has consistently come in stronger than forecast. Market forecasts have regularly been more optimistic than the Fed’s quarterly projections, which will be updated after Wednesday’s meeting.

Overall, the upcoming Fed meeting is highly anticipated, with market participants closely watching for any signals on the size of the rate cut. While expectations for a big cut have risen in recent weeks, analysts remain divided on the outcome. The Fed’s decision will have significant implications for the economy and financial markets, and investors will be closely monitoring the central bank’s actions.

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