Traders Anticipate Potential 0.5% Rate Cut by the Fed

Traders are closely monitoring the possibility that the Federal Reserve could reduce its key interest rate by half a percentage point at its upcoming meeting, although most Wall Street participants view the likelihood of such a large cut as low. Market expectations currently favor a smaller reduction of 0.25 percentage points, or 25 basis points, at the September 17 meeting. According to CME Group’s FedWatch tool, which uses 30-day Fed funds futures contracts to gauge market expectations, the probability of a quarter-point reduction stood around 88% on Monday afternoon. While the quarter-point cut is the most likely scenario, there remains a small chance—roughly 12%—that the Fed’s Federal Open Market Committee (FOMC) could implement a half-point cut, similar to the move taken at the September 2024 meeting.

Market sentiment has shifted toward easing due to weak labor market data. The August jobs report revealed only 22,000 nonfarm payroll additions and an unemployment rate of 4.3%, a near four-year high. The soft employment report has influenced policymakers to consider more aggressive rate cuts. Citigroup economist Andrew Hollenhorst noted that the weak data may drive consensus among committee members to not only resume rate cuts in September but also potentially implement further reductions in the coming months. However, Hollenhorst emphasized that a majority of the FOMC is unlikely to approve a 50-basis-point reduction, though some members—including Governors Michelle Bowman, Christopher Waller, and possibly Stephen Miran if confirmed—might favor a larger move.

Citi holds a slightly divergent view, predicting that the FOMC could reduce rates at each of its next five meetings, as officials weigh current inflation trends against ongoing labor market weakness. The rationale is that the Fed remains concerned about inflation but is increasingly focused on soft job growth, prompting considerations of successive insurance cuts. Nomura economist David Seif added that elevated inflation risks would require clear evidence of labor market stress or tightening financial conditions before the Fed could enact more aggressive easing.

Current market expectations suggest a rate cut next week, a pause in October, and another reduction in December. Historically, since FOMC chairs began holding post-meeting news conferences in 2019 under Jerome Powell, it has been uncommon for the Fed to skip meetings while adjusting rates. Nevertheless, economists like Apollo’s Torsten Slok note that policymakers face a challenging scenario: inflation remains above target while labor market data is soft, creating tension between the Fed’s dual mandate of price stability and full employment.

Ahead of the meeting, the Fed will receive new inflation data on producer and consumer prices, the last major indicators before policymakers convene. Dow Jones surveys suggest overall inflation could rise to 2.9%, while core inflation is expected to remain at 3.1%. A higher-than-expected CPI could solidify the case for a quarter-point rate cut. Slok noted that if inflation surprises to the upside, it could complicate policy discussions, highlighting the difficulty of balancing opposing pressures from the dual mandate. Despite persistent inflation, he expects the Fed to maintain a bias toward easing, suggesting that officials will increasingly focus on future inflation expectations rather than current levels.

In summary, markets largely expect a 0.25% rate cut at the September meeting, but a small chance remains for a larger reduction. Weak labor data has heightened expectations for easing, though the majority of FOMC members are unlikely to support a half-point cut. Policymakers must navigate the tension between ongoing inflation and a soft labor market, with upcoming CPI data likely influencing their final decisions. Analysts anticipate potential successive cuts in future meetings as the Fed balances its dual mandate.