Market Prices 22% Chance of 50 Basis Point Rate Cut in September

Analysts have noted that the June ADP employment figure was the worst reading since March 2023, indicating a tough moment before the release of non-farm payroll data. This data point, along with household-based data suggesting a soft market, has led to a significant shift in market expectations. The market is now fully pricing in the possibility of a rate cut in September, with a 22% probability of a 50 basis point cut.

The disappointing Non-Farm Payrolls (NFP) report has had a profound impact on market sentiment, with estimates suggesting a slowdown in job growth. This has led to a swift and decisive reaction from the market, with the probability of a rate cut in July increasing to 21.2% from 18.6% in the previous session. This shift indicates that investors are anticipating a more dovish stance from the Federal Reserve in response to the weakening labor market data.

The broader economic context supports this view, with the US dollar under pressure and the Dollar Index recording new lows since late Q1 2022. The two-year yield has declined by around 30 basis points since June 16, reflecting the market's growing expectation of a rate cut. Fed funds futures are now discounting 68 basis points of cuts this year, with a 70% chance of a third cut by the end of the year.

The market's focus on real sector data, rather than just inflation figures, has also played a role in this shift. The manufacturing PMI has been above the 50 boom/bust level this year, while the manufacturing ISM has been below 50 since October 2022. This divergence in data points has led to a more nuanced view of the economy, with investors placing greater emphasis on job market indicators.

The market's pricing of a rate cut in September is also supported by dovish commentary from some Fed members. Recent data weakness and dovish commentary have seen rate cut pricing creeping higher, with markets now fully pricing in a cut in September. This dovish stance is in line with the Fed's objectives of promoting full employment, stable prices, and moderate long-term interest rates.

In summary, the disappointing NFP report has led the market to fully price in a Fed rate cut in September. This shift in market expectations is supported by a range of economic indicators and dovish commentary from Fed members. The market's focus on real sector data and the weakening labor market data have played a key role in this shift, with investors now anticipating a more dovish stance from the Federal Reserve.