The Federal Reserve sends the clearest signal yet! Traders are starting to bet on a 50 basis point rate cut in September

Bond traders are increasing their bets, believing that the Federal Reserve will cut interest rates by 50 basis points in September, rather than the standard 25 basis points.

This sentiment is evident in the federal funds futures market, where last Thursday morning's release of weaker-than-expected CPI inflation data triggered a wave of buying in the October contracts, with buying continuing into Friday. These contracts, expiring on October 31st, already fully reflect expectations of a 25 basis point rate cut at the September 18th meeting.

Data on open interest in futures contracts from the Chicago Mercantile Exchange (CME Group Inc.) showed that last Thursday's buying spree brought new risks, with trading volume just below 260,000 contracts, setting a record for October contracts. Buying interest remained high on Friday.

Record-breaking October federal funds futures contracts betting on a 50 basis point rate cut

Any buying at higher price levels implies an expectation that more people believe the Fed may start its first easing cycle in years with a large-scale move.

Marilyn Watson, Global Head of Fundamental Fixed Income Strategy at BlackRock, said on Bloomberg TV, "The Fed is very likely to cut rates in September." While she expects a 25 basis point cut, she added, "We think they might start in July. We know the Fed has always been very, very data-dependent."

If expectations for 25 basis point cuts in both July 31st and September 18th increase, the above positions will also benefit, but traders abandoned hope for a July cut weeks ago, and no major bank on Wall Street predicted a rate cut.

On Friday, market expectations for changes in Fed policy did not shift much, as the Producer Price Index (PPI) report, although higher than expected, had minimal impact compared to the weak CPI report released on Thursday.

The settlement value of swap contracts is determined by the Fed's policy decisions, fully pricing in a 25 basis point cut in September, a total of 60 basis points cut by the end of the year, implying two 25 basis point cuts, with a 40% chance of a third cut.

Fed Sends Strongest Signal Yet of Rate Cut

Last week, Fed officials were seen as sending their strongest signal yet that they are preparing to cut rates. In public appearances last week, including two congressional hearings by Fed Chair Powell, officials showed new confidence when discussing their control of inflation and readiness to shift policy.

Better-than-expected economic data bolstered their confidence, with last week's data confirming continued downward pressure on consumer prices. Meanwhile, the labor market showed signs of weakness. Additionally, U.S. banks warned that low-income customers, after enduring prolonged high prices, are showing signs of financial strain While policymakers have not specified when and to what extent interest rates will be cut, their words clearly indicate that a new era is dawning.

Pimco economist Tiffany Wilding said that after last week's data release, a rate cut in September is now a "done deal".

Chicago Fed President Charles Evans told the Financial Times last Friday that it was a "good week" for a central bank committed to lowering inflation without causing a recession in the U.S. Powell told lawmakers that the Fed does not need to focus primarily on inflation because the Fed has made "considerable progress" in containing price pressures, and the labor market also shows clear signs of cooling. Instead, the Fed faces "dual risks" and must be more aware that continuing to use high interest rates to combat the world's largest economy could inadvertently lead to excessive unemployment. San Francisco Fed President Mary Daly, a voting member in 2024, told reporters last week that a rate cut is "reasonable"