Investors expect cut to US interest rates today
Although Wall Street looks subdued, investors are expecting a cut to US interest rates today, and possibly a large cut.
According to CME’s Fedwatch tool, there’s a 65% chance that the Federal Reserve cuts US interest rates by half a percentage point today.
That leaves a 35% chance of a smaller, quarter-percentage-point, cut.
Currently, the Fed’s target rate is 5.25%-5.5%.
This level of uncertainty means there’s likely to be a strong market reaction when the Fed announcement is made at 2pm Eastern time (7pm UK time).
You’d have to go back over 15 years to find such an uncertain situation this close to the decision, says Jim Reid, market strategist of Deutsche Bank.
He told clients:
A lot of money will be made and lost today.
I’ve waivered both ways over the last few days and I’m surprised the Fed has left pricing so uncertain at this stage. However in an era of heavy forward guidance it’s refreshing to see a little less certainty. If that was more widespread I think it would be more rather than less helpful.
If you think you know exactly what the central bank will do it is likely to promote more over exuberance in markets which in turn requires a bigger opposite reaction later. I’m sure they’ll be those taking the opposite view though.
Key events
Callum Jones
A Harris poll for The Guardian earlier this year – which found almost three in five Americans wrongly believed the US was in recession – underlined the gap between how the world’s largest economy is doing, and how people think it’s doing.
“If you stopped the average person in the street, they would have no idea” how many jobs had been created, or how many people were out of work, in any given month, Stephanie Kelton, a professor of economics and public policy at Stony Brook University, noted recently.
Ahead of the US presidential election, voters consistently rank the economy as a top issue. But even those who do follow the latest official data reports are unlikely to base their decision in November on their contents.
An interest rate cut might be different. “Perhaps at the margin, in the tiniest of ways”, it could make some people start to feel better about the economy, Kelton suggested. “Maybe there’s a little bit of a vibe shift in having the rate-cutting cycle begin, and knowing it’s under way.”
Callum Jones
The most recent official inflation and employment releases broadly reinforced confidence that the Fed would cut rates today.
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The latest consumer price index, released last week, showed that price growth softened in August to its lowest level since February 2021.
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The latest jobs report underlined how the labor market’s growth has slowed this year, 142,000 jobs in August.
Policymakers will have carefully scrutinized both these reports ahead of the decision.
Callum Jones
Ahead of the Fed’s announcement, it’s worth noting why Wall Street is so confident that this time around – having kept rates on hold at the past eight consecutive meetings – it will finally act.
Jerome Powell, the central bank’s chair, all but declared last month it would cut rates when policymakers convened for their September meeting.
“The time has come for policy to adjust,” he told an annual symposium for central bankers at Jackson Hole in Wyoming.
While Powell added that the “timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks”, he said: “The direction of travel is clear.”
Many investors have heard enough. Money markets currently put the chances of a 50 basis-point cut at 55%, according to CME’s FedWatch tool.
Why is the Fed cutting rates?
The Federal Reserve is expected to announce an interest rate cut for the first time in four years at 2pm. Many economists see this moment as the end of an era, and the beginning of the end of the central bank’s fight against inflation.
It primarily looks at two things when considering the interest rate: price growth and the labor markets.
Following years of pandemic-related turmoil in the economy, inflation began to rapidly increase. The Fed hiked rates 11 times over a period of about a year and a half, from March 2022 until July 2023, the last time it increased rates.
Since then, inflation has slowed significantly. The labor market has remained strong, but has started to cool.
As the most recent inflation and jobs data seemed to both show cooling, Fed officials started signaling late in the summer that it was time to cut rates.
Wall Street is still calm, with under two and a half hours until the Fed’s decision hits the wires.
The Dow Jones industrial average is currently down 0.08%, or 34 points, at 41,571 points.
The broader S&P 500 index is down 6 points or 0.11%. at 5,628 points, and the Nasdaq Composite is also very slightly lower.
And with that, I’m handing over to my colleague Lauren Aratani…. GW
A survey published yesterday by CNBC found that 84% of the 27 respondents, including economists, fund managers and strategists, thought the Fed would cut by a quarter percentage point.
That left 16% predicting a half-point decrease.
So again, that clashes with the pricing in the futures market, where a half-point cut is more likely.
CNBC says:
The major difference could be that survey respondents appear less worried about the economy overall than futures markets, and more convinced the Fed has time to enact gradual rate cuts.
Seventy-four percent said the September rate cut comes in time to preserve a soft landing, with just 15% saying it’s too late.
Analysts at Oxford Economics reckon fears of a US recession have been overcooked.
They told clients today:
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The Fed will begin its long-telegraphed pivot today, but we think one-year ahead rates pricing by markets is too dovish and inconsistent with our soft-landing view.
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Growing concerns that the US might be slipping towards a recession are unfounded and we think recent data remain consistent with a more orderly and benign growth slowdown.
A dovish performance from the Federal Reserve today could drive the gold price to new highs, analysts say.
Gold has already hit a series of record highs this year, as it climbed by 25% since the start of January to almost $2,600/ounce this week.
Ricardo Evangelista, senior analyst at ActivTrades, suggests a steep cut to US interest rates could drive gold higher, as it would weaken the dollar (in which gold is priced).
Attention is now firmly on today’s Fed rate decision, with a growing number of traders anticipating a 50-basis-point cut. If this scenario materializes, it would likely weaken the dollar, boosting gold prices.
The extent of the upside for precious metals will depend on how dovish Jerome Powell’s tone is during his post-announcement address. Should the Fed Chair signal the possibility of further rate cuts later in the year, gold could be poised to reach new record highs.
US housing starts rebound
Construction of single-family US homes rebounded sharply in August, new data shows.
Housing starts – a measure of how many construction projects got underway – jumped by 9.6% in August to an annual rate of 1.356 million units, the Commerce Department’s Census Bureau reported.
The increase was driven by a near-16% jump in single-family housing starts.
The increase suggests building work got underway again last month after Hurricane Beryl disrupted the sector in July.
Bloomberg report that futures traders have made a record number of wagers that the Federal Reserve will make an “outsized cut” to rates today.
That means there could be sharp losses if the Fed only lowers borrowing costs by a quarter of one percentage point (25 basis points) today.
Bloomberg explain:
Bond investors that have been frantically wagering on the size of the Federal Reserve’s first interest-rate cut in four years are about to find out whether they made the right trade.
The market is fully pricing in a quarter-point rate reduction on Wednesday, when the US central bank is expected to kick off its rate-cutting cycle, with the chance of a bigger move viewed as a coin-flip. Treasuries have rallied into the decision, climbing for a fifth-straight month and driving short-dated yields — those most sensitive to Fed policy — to their lowest in two years.
Deutsche Bank poll: 50bp cut would be a shock
Just in: A majority of financial experts polled by Deutsche Bank today expect the Fed will only cut US interest rates by a quarter of one-percent.
Ir’s a slighly imprompu poll, conducted by Deutsche’s market strategist Jim Reid since 7am UK time among readers of his morning research note (highly recommended, by the way).
1,400 people took part – and the poll showed that they are expecting an average of 34.4 basis points of cuts today. That’s less than the futures market is predicting [it’s also not going to happen; the Fed will either do 25bo or 50bp].
Reid says:
62% [of respondents] expect 25bps and 38% expect 50bps. This suggests 50bps would be a bigger shock than 25bps to a broader global financial market audience, the opposite way round in terms of biases to what Fed fund futures contracts are telling us.
As flagged earlier, the futures market reckons a 50bp cut is more likely than a 25bp one – so there’s a disconnect between that and the Deutsche survey…
The US dollar could rally if the Federal Reserve only cuts interest rates by a quarter of one percent, or sink if the Fed plumps for a half-point cut.
And that movement will have implications for other assets, including shares, oil and gold.
Rania Gule, senior market analyst at XS.com, explains how it could pan out:
If the dollar drops significantly due to a large rate cut, it could lead to higher prices for dollar-denominated commodities such as gold and oil. A weaker dollar makes these assets cheaper for foreign investors, boosting demand for them. This scenario could lead to a rise in gold prices, as gold is considered a haven during times of economic uncertainty. Similarly, a weaker dollar could support oil prices, especially with continued strong demand from emerging markets and reduced supply from OPEC.
Regarding equities, the impact of a rate cut on the dollar could be twofold. On one hand, lowering interest rates reduces borrowing costs, enhancing companies’ ability to invest and expand, which supports stock markets. On the other hand, if commodity prices like oil rise due to a weaker dollar, companies that heavily rely on importing raw materials may face pressure on their profit margins.
Latest CME FedWatch odds:
• 50bps: 65%
• 25bps: 35%For the first time in over a year, there isn’t a clear-cut consensus heading into this FOMC, with no option priced in over 90%.
This meeting is set to be a volatile one, as the market will not only need to react to the… pic.twitter.com/J0W38nMamJ
— Storm Trading (@TheStormTrading) September 18, 2024