What Do Markets Expect From the Federal Reserve on Interest Rates?

Market participants breathed a sigh of relief when Federal Reserve Chair Jerome Powell signaled during a speech on Friday that interest rate cuts are coming. The question now is: Will the central bank be as aggressive in its easing as investors expect?

Markets have been anticipating the Fed’s pivot for most of this year, and have tended to overestimate how quickly the central bank would cut rates. At the start of the year, markets were pricing in the likelihood that the Fed would trim as much as one-and-a-half percentage points from its benchmark fed funds rate by the end of 2024, with cuts starting in March. Several months later, the influential rate remains exactly where it’s been for over a year, at its highest level since 2001.

In his eagerly anticipated remarks Friday at the Jackson Hole Economic Policy Symposium, Powell said the “time has come for policy to adjust” as inflation has eased and the labor market has cooled, though he stopped short of promising that a rate cut would be made at the Fed’s next policy meeting in September. “The direction of the travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks,” he said. 

On Wall Street, however, the speech was taken as effectively a guarantee that rates will be lowered next month. 

“Chair Powell’s Jackson Hole speech confirmed that the Fed is now at the point of paring,” wrote Bank of Montreal (BMO) analysts on Friday. “Indeed, we judge we’re also now at the point where the data no longer have to persuade the Fed to cut policy rates.” 

How Steeply Will the Fed Cut Rates?

Markets are currently pricing in about a 75% chance that the Fed will cut the benchmark rate by at least a full percentage point from its current range of 5.25%-5.50% by the end of the year, according to the CME Group’s FedWatch tool, which forecasts rate movements based on fed funds futures trading data. If the Fed follows that script, it would need to cut the rate by half a percentage point, or 50 basis points, at one of its three remaining monetary policy meetings in 2024.

Powell’s speech shored up “expectations for an already priced in 25-bps rate cut in September while his cautious tone about the health of the labor market left the prospects of 50 bps on the table,” wrote market analysts Tom Essaye and Tyler Richey in a report Monday. 

BMO analysts, meanwhile, don’t expect the data to justify larger cuts. “Signs of an economic slowdown are becoming more visible now, but fears that the Fed needs to make bigger-than-usual 50 basis point cuts to avoid a recession are also not strongly supported by the data,” Chief U.S. Economist Scott Anderson wrote on Friday. 

Traders are holding out hope, though. As of early Tuesday afternoon, fed fund futures trading data implied a 36% chance of a 50 basis point cut in September, up from less than a 30% likelihood priced in a week ago.