All eyes will be on the Federal Reserve next week. The market remains uncertain about how much the US central bank will cut interest rates at its monetary policy meeting and at what pace it will reduce borrowing costs in the coming months. The S&P 500 index (.SPX) is only 1% behind July’s record high. However, the market has seen volatility amid concerns about the economy and eyes on the size of the cut at the Fed’s September 17-18 meeting.
After sharp fluctuations throughout the week, Fed Funds futures on Friday showed that traders are estimating a roughly equal probability of a 25 basis point cut and a 50 basis point cut, according to CME Fedwatch. Now the market is watching whether the Fed will counter weakness in the labor market with an aggressive rate cut?
Investors will be watching the US Fed’s new economic projections and its outlook on interest rates. According to LSEG data released late Friday, markets are anticipating a 115 basis point rate cut by the end of 2024. The Fed’s June forecast called for a 25 basis point rate cut for this year.
Walter Todd, chief investment officer at Greenwood Capital, said the central bank should opt for a 50 basis point rate cut on Wednesday. He pointed to the gap between the 2-year Treasury yield, which is around 3.6%, and the fed funds rate, which is 5.25%-5.5%. That gap is “a sign that the Fed is actually tighter than the market,” Todd added. “They’re late in starting this rate cut cycle and they need to finish it.”
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Expectations of aggressive rate cuts have fueled the Treasury rally. The 10-year bond yield has fallen nearly 80 basis points since early July to around 3.65%. It is close to its lowest level since June 2023.
Mike Mullaney of Boston Partners said that if the Fed eases less this year than the market expects, bonds will have to be re-rated, which will push up yields. Mullaney added that rising yields could put pressure on stock valuations.