Too hasty again? Traders are betting that the Federal Reserve will cut interest rates by 175 basis points by next year

According to Reed, except for an example in the mid-1980s when real interest rates remained extremely high, the Federal Reserve only significantly lowers interest rates when the U.S. economy is contracting.

From now until the end of next year, while an economic recession is not impossible, recent data only suggests a slight cooling in the economy and labor market.

Reed believes that the most reasonable explanation for this aggressive rate cut bet is that traders are once again expressing what he describes as a "dovish bias" in interest rates, rather than sensing an economic downturn. After all, according to Reed's calculations, this would be the eighth time traders have bet heavily on a significant rate cut by the Federal Reserve since it began raising rates in March 2022, with the previous seven outcomes all proving to be contrary to expectations.

However, Reed still emphasizes two scenarios in which the Federal Reserve may cut rates seven times in the next 18 months.

The first scenario is that the U.S. economy will indeed fall into a recession by the end of 2025. The other scenario is that the uniqueness of the post-recession economy means the Federal Reserve can actively cut rates without facing the risk of inflation rebounding, even without a recession.

The latter scenario would be a "perfect soft landing," technically possible but not very realistic in Reed's view.

Investors are hoping that Powell will provide more guidance on the Fed's rate cut plans later this week. Traders see the rate cut starting in September as a foregone conclusion.

Whether Powell signals a rate cut in September could have a significant impact on the market. Investors have shifted from large-cap and semiconductor stocks to small-cap stocks this month, widely attributed to renewed hopes for a rate cut after the weaker-than-expected June inflation report