(Bloomberg) — Traders are entertaining the prospect of a large Federal Reserve interest-rate cut once again, spurring a rally in US government bonds and injecting a fresh dose of uncertainty over next week’s decision.
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After virtually discounting the possibility entirely over the past few days, the market-implied chance of a 50-basis-point cut has shot back up to roughly 30%. The trigger for the repricing was a Wall Street Journal report Thursday that Fed policymakers were considering whether to reduce rates by a regular quarter point, or opt for half a percentage point.
The debate over how big the Fed’s first rate cut this cycle will be has captivated markets for weeks. While recent resilient inflation and labor market data reinforced the case for a measured move, it hasn’t completely quashed speculation over more aggressive action. That sets the stage for a volatile few days as the Sept. 18 meeting approaches.
If pricing “stays where it is currently, it would be the first meeting in years where there’s serious uncertainty about the rates decision,” Deutsche Bank AG analysts including Henry Allen wrote in a note.
Yields on two-year notes (ZT=F), among the most sensitive to changes in monetary policy, dropped five basis points to 3.59% on Friday, while those on 10-year debt fell three basis points to 3.65%. The dollar slipped, providing a boost for major currencies.
The case for easing has been building for some time now. The central bank’s favored gauge of inflation has retreated toward its longer-term target of 2% from a high of over 7% two years ago. Disappointing US data releases, including a surprise drop in jobs openings, have further supported calls for Fed cuts.
“The Fed could arguably deliver a larger 50-basis-point cut citing Fed funds being well above the bank’s estimate of neutral,” said Prashant Newnaha, a senior Asia Pacific rates strategist at TD Securities in Singapore.
But others worry that a half-point cut by the Fed next week would be an over reaction, and that the economy is not in urgent need of looser monetary policy.
“The market is a bit ahead of itself,” said Mark Dowding, the CIO at RBC BlueBay, who said the Fed is likely to to reduce rates gradually, starting with a 25-basis-point cut. “From our perspective, it looks like the economy is doing fine.”
—With assistance from Alice Gledhill and Anchalee Worrachate.
(Adds investor comment in final paragraph.)
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