Traders Scale Back Bets On 50-Basis-Point September Rate Cut Ahead of Friday's Key Fed Inflation Gauge Data

An upward revision of U.S. gross domestic product growth in the second quarter has led speculators to reconsider their bets on a substantial 50-basis-point rate cut next month.

This adjustment comes as the market eagerly anticipates the release of the Personal Consumption Expenditure (PCE) price index – the Fed’s favorite inflation report – scheduled for 8:30 a.m. ET Friday.

The U.S. economy grew at an annualized rate of 3% in the last quarter, according to the government’s second estimate, which revised earlier projections of 2.8% growth.

The increase was largely driven by household spending, which was also revised upward from 2.3% to 2.9%. This strong boost in GDP, alongside recent jobless claims that showed no significant cooling in the labor market, has caused traders to slightly scale back their expectations of a larger rate cut from the Federal Reserve.

Traders Start To Question Need For Large Rate Cuts

The market-implied probability of a 50-basis-point rate cut has now fallen to 32%, down from 38% the previous day, according to the CME Group‘s FedWatch tool.

Conversely, the likelihood of a smaller 25-basis-point cut has risen to 68%.

Looking further ahead to the Federal Open Market Committee meeting on Nov. 7, there is an even split in the market’s expectations between a 25-basis-point and a 50-basis-point rate cut that month.

Overall, market participants are pricing in a total of 87 basis points in rate cuts by the end of the year, suggesting at least three consecutive 25-basis-point reductions.

‘A Roaring 2020s Kind Of Day’

“Today was a Roaring 2020s kind of day,” said Ed Yardeni, president of Yardeni Research. He highlighted with enthusiasm that the Dow Jones Industrial Average surged to another record high and the broader market rose, even as Nvidia Corp. stock dipped after surpassing quarterly earnings expectations.

“A robust jobs market, rising real wages, increased productivity, and record corporate profits and cash flow suggest the bull market has room to run,” Yardeni concluded.

All Eyes on the Fed’s PCE Report

Wall Street economists, as tracked by TradingEconomics, predict the headline PCE annual inflation rate will edge up from 2.5% in June to 2.6% in July, breaking a three-month streak of declines. On a monthly basis, the headline PCE is expected to increase by 0.2%, up from 0.1% in June.

Core PCE inflation, which excludes volatile food and energy prices, is likely to rise from 2.6% to 2.7% annually, with a consistent monthly increase of 0.2%.

A higher-than-expected PCE report could strengthen the U.S. dollar index (DXY), as tracked by the Invesco DB USD Index Bullish Fund ETF UUP. In turn, Treasury yields might climb, potentially causing declines in the iShares 20+ Year Treasury Bond ETF TLT.

In contrast, a lower-than-expected PCE reading could provide a further boost to equities. The SPDR S&P 500 ETF Trust SPY and the Invesco QQQ Trust, Series 1 QQQ are likely to see buying flows if the data supports the likelihood of future rate cuts.

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Federal Reserve illustration created using artificial intelligence via MidJourney.