Federal Reserve Rate Cuts Expected in September and December, Dollar Weakens

Traders are anticipating that the Federal Reserve will reduce interest rates twice this year, with the first cut expected in September and the second in December. This expectation is based on the current economic conditions and the Fed's policy stance. The likelihood of a rate cut in September has increased significantly, with traders pricing in a high probability of a move during that month. The dollar has weakened in response to these expectations, as investors anticipate lower interest rates which typically reduce the attractiveness of the currency.

The anticipation of rate cuts comes after the Federal Reserve lowered interest rates three times between September and December of the previous year. The central bank has been on hold since then, waiting for significant economic indicators to warrant further action. Traders are now pricing in two rate cuts of 25 basis points each, in September and December, totaling 50 basis points of easing for the year.

The expectation of rate cuts is driven by several factors, including the current state of the economy and inflation. Inflation remains above the Fed's 2% target, and while the job market is solid, there are signs of a slowdown on the horizon. Consumer surveys show widespread pessimism due to rising prices and cuts in federal spending. The specter of "stagflation"—stagnant economic growth with rising inflation—is hanging over consumer sentiment. Additionally, the on-again/off-again trade war has made businesses cautious about investing and hiring, further contributing to economic uncertainty.

The Federal Reserve's dual mandate of price stability and full employment is also a factor in the expectation of rate cuts. The unemployment rate is low, but inflation has stalled in the 2.5% to 3.0% region, well above the Fed's target. One-year inflation expectations have been rising and stand at the highest levels since the COVID-19 pandemic. The Fed wants to see inflation "well anchored" near its 2% target, which is a reason for the Fed to remain on hold. However, the expectation of rate cuts suggests that traders believe the Fed will eventually need to act to support the economy.

The anticipation of rate cuts has also led to a weakening of the dollar, as investors reduce expectations for U.S. economic growth due to supply chain disruptions and lower consumer demand. The dollar has weakened by about 7% since the trade war began, as investors react to the uncertainty and potential drag on economic growth. If tariffs are removed or rolled back significantly, the dollar likely will rebound, and Treasury yields probably will decline.