As the US and other major stock markets grapple with the selling pressure and a slew of weak economic data, speculation of a rapid easing of the US monetary policy is mounting, with some market participants even betting on an off-cycle rate cut by the US Federal Reserve.
The central bank's response to the recent economic signals has left market participants questioning if the US Fed is behind the curve. Market participants are now betting that the Federal Reserve will initiate aggressive interest rate cuts as early as September.
The US Labor Department’s report for July revealed that only 114,000 jobs were added, significantly below expectations, while the unemployment rate edged up to 4.3 percent from 4.1 percent in June. Following the release, interest rate futures indicate nearly 70 percent probability of a half-percentage-point rate cut at the Fed’s September 17-18 meeting, said Reuters. This contrasts sharply with previous expectations of a more modest quarter-point cut.
Has the US Fed fallen behind the curve on interest rate cuts?
Market analysts and economists have rapidly adjusted their forecasts, with Goldman Sachs predicting a series of steady rate cuts at next few FOMC meetings. Citigroup and JP Morgan Chase both expect a series of half-percentage-point cuts in September as well as December.
Also read: Risk of a US recession real, say experts
JP Morgan too also raised a strong possibility for an off-cycle rate cut before the Fed’s next scheduled meeting, reflecting the market’s view that the Fed has been too slow in adjusting its policy stance given the recent economic cues. Earlier last week, the US Fed opted to keep the central bank's policy rate unchanged in its current 5.25-5.50 percent range.
“If Powell knew then what he knows now, he probably would have cut rates. By keeping rates on hold while inflation fell, they’ve applied too much pressure on the brakes,” Brian Jacobsen, Chief Economist at Annex Wealth Management, said in a Reuters report.
Going ahead, unless the upcoming US CPI inflation reports are “pretty shocking”, the US Fed might struggle to justify deferring rate cuts further, said Stuart Cole, Chief Macro Economist at Equiti Capital, per a Reuters report.
On the other hand, Marc Ostwald, Chief Economist and Global Strategist at ADM Investor Services, said that while the Fed is not necessarily “behind the curve” in a precise sense, the prevailing conditions strongly suggest a rate cut is imminent. “This essentially cements a rate cut in September, whatever we get from July CPI,” he added.
How deep could the US Fed cut rates? How rapid will monetary easing be?
Global markets have reacted negatively to the Fed’s cautious stance, with Japan’s Nikkei index plunging over 14 percent on Monday, 5 August, and the Yen rallying more than a percent on expectations that the Bank of Japan will continue the tightening. US futures tumbled, with S&P 500 futures down 2.64 percent, and Nasdaq futures down nearly 5 percent.
Also read: 'Wait and watch', not 'buy on dip', say experts amid market fall
Concerns are also mounting that the Fed's decision to hold interest rates at a two-decade high could risk a deeper economic slowdown.
Reuters said that traders are increasingly betting on more than 115 bps of rate cuts this year. Bloomberg said traders are betting that the Fed will cut rates by more than a full percentage point in 2024, with an ‘increased chance’ of an outsized 50-basis point cut in September.
Brian Rose, Senior US Economist at UBS Group AG, said, “With the unemployment rate above and core PCE inflation now below the Fed’s year-end forecasts, we believe that the balance of risks favours more aggressive action by the Fed.”
Despite these expectations, some bond traders caution that the market may be over-reacting. Kevin Flanagan, Head of Fixed Income Strategy at WisdomTree, warned, “The market is overshooting and getting ahead of itself like we saw late last year. You need validation from more data.”
Recession concerns driving expectations
On Sunday, Goldman Sachs economists increased the probability of a US recession in the next year to 25 percent from 15 percent, but said there are several reasons not to fear a slump. The Fed has a lot of room to cut rates and can do so quickly if needed, they said.
Also read: Nifty, Sensex bleed amid weak global cues: Here are 5 factors that dampen sentiment
Nonetheless, Goldman Sachs’ prediction of a potential recession has added weight to the discussion about rate cuts. “With recession risks on the rise, the Fed might need to act more swiftly to cushion the economy from a severe downturn. A mid-cycle rate cut could be a crucial step in mitigating the impact of a potential recession,” said Goldman Sachs.
JPMorgan economists have raised a more dire possibility, predicting a 50 percent probability of a US recession. “Now that the Fed looks to be materially behind the curve, we expect a 50 basis points cut at the September meeting, followed by another 50 basis points cut in November," said economist Michael Feroli.
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