Investors are raising bets on the Fed’s interest rate halving

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Investors sharply increased their bets on a half-percentage-point rate cut by the Federal Reserve next week, as the U.S. central bank prepares to cut borrowing costs for the first time in more than four years.

Traders in the swaps markets are currently pricing in a 43% chance that the Fed will opt for an absolute cut in an attempt to prevent high rates from hurting the economy.

On Thursday, they set the price with just a 15 percent chance.

Mark Dowding, chief investment officer at RBC BlueBay Asset Management, said a half-point cut was now “very much in play” after being “almost completely priced out” at one point on Thursday.

Markets still assign a 57% chance of a cut of less than a quarter point, but the likelihood of such a move is down significantly from Thursday.

Late Thursday, the Financial Times and Wall Street Journal reported that the Fed faces a close call on whether to cut by half or a quarter point.

Former New York Fed President Bill Dudley said on Friday he saw a “strong case” for a half-percentage-point cut next week, stressing the restrictive impact on raising the current rate from 5.25 percent to 5.5 %, a 23 percent. a year.

The Fed typically moves in quarter-point increments, but a 0.5 percentage point cut could serve as a preemptive measure if officials believe the economy is at risk of slowing too quickly.

Some officials thought it was “plausible” that the Fed cut rates at its last meeting in July, minutes from that meeting showed, suggesting a bigger move could help the central bank recover as inflation eased and more since then.

“The path of least regret for the Fed is to lead by 50 (basis points),” said Tim Duy, chief economist at SGH Macro Advisors. “It’s the only logical policy choice.”

Gabriele Foà, a fund manager at Algebris Investments, said the Fed is “better. . . frontload(ing) cuts’ rather than the risk of ‘falling behind the curve in a downturn’.

Wednesday’s Fed meeting, the last before November’s presidential election between Kamala Harris and Donald Trump, is highly charged as officials try to steer the world’s largest economy toward a “soft landing” in which inflation is tamed without trigger a recession.

A closely watched survey from the University of Michigan showed that consumers’ expectations of inflation for the coming year fell to 2.7 percent, the lowest rate since late 2020. The university’s report on Friday also showed that consumer sentiment for September rose to four months. high.

The yield on the two-year U.S. Treasury note, which tracks interest rate expectations and moves inversely to prices, fell 0.05 percentage point to 3.6 percent on Friday.

Stocks rose, with the S&P 500 up 0.7 percent and on track for its best weekly performance this year.

Analysts said the meeting was one of the most uncertain in years after recent data painted a mixed picture of an economy with some remaining price pressures and weakness in the labor market.

Figures this week showed headline inflation eased to 2.5% – close to the Fed’s 2% target – but core inflation rose more than expected by 0.3% month-on-month, partly due to pressures on the real estate market.

“If the inflation that’s lingering in the housing and shelter sector remains, a 50 basis point cut could accelerate or amplify that,” said Wylie Tollette, chief investment officer at Franklin Templeton Investment Solutions, which expects a quarter of point. cut.

He added that the election could also complicate the case for a big cut.

Trump suggested that a Fed rate cut would help Harris as acting vice president, “even though it’s something I know he shouldn’t do.”

Tollette added, “The Fed’s way is they want to do what’s right for the economy, but I don’t think they want to be perceived as benefiting the incumbent by cutting more aggressively.”

But with unemployment rising and demand slowing, Fed officials want to prevent further weakening of the labor market.

Fed Chairman Jay Powell said last month that the central bank would “do everything we can to support a strong labor market as we make further progress toward price stability.”

Salman Ahmed, global head of macro at Fidelity International, said: “It’s a game of cat and mouse. . . we’ve started the cutting cycle, but there’s still a lot to be determined.”

He added that for most of the post-pandemic cycle it has become “very clear that neither the market nor the Fed has any idea what the Fed is going to do.”

Last December, the Fed forecast cuts of 75 basis points in 2024 – but by June it had suggested it would only cut by a quarter of a point for the year.

Additional reporting by Kate Duguid and Laurence Fletcher