Interest rate expectations for the Federal Reserve have undergone volatile swings recently due to conflicting economic data. At the beginning of August, a 50-basis-point rate cut in September seemed like a done deal to many market participants. Some even speculated about the possibility of an emergency cut to counter an impending recession.
However, these expectations have significantly shifted, with markets now pricing in a higher likelihood of a more modest 25-basis-point cut.
Fed Chair Jerome Powell also dismissed the option of a 50-basis-point cut in September during the July meeting, signaling a more cautious approach.
As of Aug.15, the CME Group’s Fed Watch Tool shows that the implied market probability of a 25-basis-point cut has surged to 75%, up from 64% the previous day and 45% a week earlier. Meanwhile, the likelihood of a 50-basis-point cut has plummeted to 25%, down from over 50% a week ago and nearly 100% after the release of the July jobs report at the start of the month.
Betting markets tracked by Polymarket have also seen a sharp decline in the implied chances of a 50-basis-point cut, which fell to 14% from a peak of 68% on Aug. 5.
Historically, the Fed has initiated its rate cut cycles with a 50-basis-point reduction only three times since 2000: in January 2001 (dot-com bubble burst), September 2007 (Lehman default), and March 2020 (COVID-19 pandemic).
“We remain comfortable with our view that the Fed will cut rates only twice this year, by 25bp each, in September and December,” Bank of America economist Aditya Bhave wrote in a note.
Bhave suggested that, given the current solid economic activity and slightly higher-than-desired inflation, there is no need for the Federal Reserve to implement large or accelerated rate cuts. At present, markets are anticipating 30 basis points of cuts by September and under 95 basis points by the end of the year. These expectations were higher following the release of the July jobs report, with markets then pricing in 48 basis points of cuts by September and 117 basis points by year-end.
Economic Data Defies Recession Risk
Retail sales unexpectedly surged 1% in July, providing evidence that consumer spending remains robust. This 1% monthly increase followed a downwardly revised 0.2% drop in June and far exceeded forecasts of a 0.3% gain. It was the largest increase since January 2023, with motor vehicle and parts dealers leading the way with a 3.6% rise, followed by electronics and appliance stores at 1.6%.
Meanwhile, the number of people filing for unemployment benefits fell by 7,000 to 227,000 for the week ending Aug. 10, defying market expectations of a slight increase to 235,000. This marks the second consecutive weekly decline since unemployment claims reached a near-one-year high of 250,000 in late July.
“This morning’s data tsunami showed that the labor market remains in good shape and is fueling consumer spending,” said veteran Wall Street investor Ed Yardeni.
Overall, the latest economic data suggests that the U.S. economy is not as weak as it appeared a few weeks ago, reducing the risks of a recession and the need for significantly looser monetary policy, which could undermine the fight against inflation.
Treasury Yields Move
The shifting market expectations on interest rates have triggered wild movements in Treasury yields. The policy-sensitive 2-year Treasury yield had plunged to as low as 3.65% on Aug. 5 before rebounding to 4.11% on Aug. 15.
Similarly, the 10-year yield had initially fallen to 3.66% before climbing back to 3.95%.
Long-dated Treasury bonds, as tracked by the iShares 20+ Year Treasury Bond ETF TLT, had rallied 9% from July 24 to Aug. 5 before pulling back 3% through Aug. 15.
Read Next:
Image created using artificial intelligence via Midjourney.
© 2024 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.
Comments
Trade confidently with insights and alerts from analyst ratings, free reports and breaking news that affects the stocks you care about.
