Wall Street Anticipates Federal Reserve Interest Rate Cut

Market participants raised their bets on Friday that the Federal Reserve will dive headfirst into rate cuts at its policy meeting next week. Traders put the odds that the Federal Open Markets Committee will cut its benchmark federal funds rate by 50 basis points next Wednesday at 47%, according to CME’s FedWatch tool, which uses fed futures trading data to forecast interest rate decisions. Markets saw a slightly higher chance (53%) of a smaller 25-basis-point cut.

The chances of a cut of 50 basis points, or half a percentage point, were up significantly from earlier in the week when inflation data surprised to the upside, providing markets with a fresh reminder that prices are still rising faster than the Fed would like. That data seemed to confirm for Wall Street that, despite the risks of a cooling labor market, officials would approach rate cuts cautiously to avoid undoing the progress they’ve made in taming decades-high inflation.

Former New York Fed President Bill Dudley, who said at a forum in Singapore on Friday that he saw “a strong case” for a 50-basis-point cut. Dudley argued that the rising risks to the labor market outweighed any lingering upside inflation risks. The pace of job gains has slowed dramatically in recent months—89,000 in July and 142,000 in August, compared with a monthly average of more than 200,000 in the first half of the year—raising concerns that the labor market has weakened more than expected and could rapidly deteriorate further.

Does Wall Street Want a Big Cut?

The Fed has, over the last few years, tended to act as the market expected. During the 2022-2023 tightening cycle, even though market expectations sometimes shifted in the week before the rate decision, the Fed’s move was always what markets thought was the most likely outcome.

With markets almost evenly split on whether it’ll be a 25-basis-point or 50-basis-point cut next week, the door is wide open for that pattern to be broken, giving Wall Street substantial leeway in interpreting the Fed’s action.

Over the last 20 years, most 50-basis-point cuts have come amid or immediately before a full-blown economic crisis. A big cut at next week’s meeting could signal panic on the part of policymakers and send markets reeling.

However, Wall Street, like Dudley, clearly sees a case for a large cut next week, in part because interest rates are so high—at least by 21st-century standards. Dudley on Friday argued that the federal funds rate is currently as much as 200 basis points above the neutral rate, at which policy is neither accommodative nor restrictive. “So the question is, ‘Why don’t you just get started?'” he said.

Wall Street could agree and see a big rate cut next week as simply the appropriate first step in the normalization of interest rates after an incredibly abnormal few years.

Overall, the anticipation of a rate cut by the Federal Reserve has created uncertainty in the market. While some believe a 50-basis-point cut is necessary to address the weakening labor market, others are concerned that such a large cut could signal panic and potentially lead to an economic crisis. Wall Street, however, sees a case for a big cut as a necessary step in the normalization of interest rates. The outcome of the Federal Reserve’s policy meeting next week will have significant implications for the market and the economy as a whole.

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