- US inflation reports revealed that price pressures were higher than expected in August.
- A retired Fed official, Bill Dudley, noted a strong case for a massive cut.
- US jobless claims increased from 228,000 to 230,000 last week.
Interest futures fell on Thursday before recovering on Friday due to fluctuations in Fed rate cut expectations. Market participants went from expecting a 25-bps rate cut next week to pricing a higher likelihood of a more significant rate cut.
US wholesale inflation (Source: Bureau of Labor Statistics)
Investors were initially more convinced that the Fed would implement a small rate cut next week. Notably, major US inflation reports revealed higher prices than expected in August. Core consumer prices rose by an unexpected 0.3%. Meanwhile, producer prices increased by 0.2%, beating estimates of 0.1%. Nevertheless, the general trend remained down.
Consequently, looking at the state of inflation, it was clear that the Fed could start cutting rates slowly. Furthermore, although employment figures spooked investors last month, the labor market improved in August. Job growth slowed, but not enough to warrant a super-sized rate cut. At the same time, the unemployment rate fell from 4.3% to 4.2%. As a result, bets for a 50-bps rate cut have consistently declined since last month.
By Thursday, investors were pricing a 14% likelihood of such an outcome. However, this suddenly changed overnight after news outlets reported that there was a high chance the Fed would cut by 50 bps. At the same time, a retired Fed official, Bill Dudley, noted a strong case for a massive cut. This led to a U-turn as investors moved to price a 47% chance of a 50-bps rate cut.
As a result, Treasury yields and the dollar plunged. Meanwhile, interest futures recovered from the previous session’s lows. Other data on Thursday revealed that US jobless claims increased from 228,000 to 230,000 last week, indicating looser market conditions.
After a week of high-impact reports, all eyes are now on next week’s FOMC policy meeting. Investors have scrutinized all major reports showing a slowdown in the US economy. At the same time, inflation is on a consistent downtrend, nearing the 2% target. The Fed will cut rates by 25 or 50 bps. The uncertainty in the market remains high. Therefore, the outcome could lead to a lot of market volatility. At the same time, investors will watch the messaging for policy after September.
