From now until the end of next year, traders have been betting on aggressive rate cuts from the Fed, and it looks like they might be wrong again.
According to an email commentary from Deutsche Bank strategist Jim Reid, traders are now expecting 175 basis points of rate cuts over the next 18 months, the highest since early March. Reid noted that except for one instance in the mid-1980s when actual rates were still very high, the Fed only cut rates so aggressively when the economy was in recession.
While a recession before the end of next year is not impossible, recent data suggests that the cooling of the economy and labor market is only mild. Reid argued that the traders’ move might be more of an “intrinsic dovish bias” than a forecast of a downturn. This is the eighth time Reid has calculated that traders are predicting aggressive rate cuts only to have them reversed.
Reid also pointed out two scenarios that could lead to seven rate cuts over the next 18 months. The first is a recession before 2025; the second is the unique nature of the post-Covid economy, which could allow the Fed to cut rates significantly without triggering inflation even without a recession. The latter would be a “soft landing,” which Reid thinks is unlikely, even if technically possible.
Investors hope that Fed Chair Powell will provide more guidance on the central bank’s rate-cut plans later this week, as traders are almost certain that rate cuts will begin in September. Whether Powell hints that September is indeed the month when rate cuts will begin could have a significant impact on the market. Since the June inflation report fell short of expectations, the market has shifted to small-cap stocks, while tech giants and semiconductor stocks have pulled back.
According to FactSet data, iShares Russell 2000 exchange-traded funds rose 11.7% in July, while the S&P 400 Mid Cap index rose 10.6%. In contrast, the Nasdaq Composite, which is dominated by tech stocks, fell 2.1% over the same period.