Fed Rate Path Uncertain Amid Strong Economic Data and Fed Internal Divisions

On September 25, economic data revealed that the U.S. Q2 GDP recorded its fastest growth in nearly two years, while initial jobless claims fell to their lowest level since mid-July. This robust data has increased the uncertainty around the Federal Reserve's rate cut path, leading to a decline in market expectations for a rate cut in October.

According to CME FedWatch, following the economic data release, the market's expectation for a 25-basis-point rate cut by the Fed in October fell from 91.9% to 85.5%, and expectations for a December cut also declined.

Recently, speeches by Federal Reserve officials have highlighted internal divisions: Vice Chair Bowman and acting governor Milan support a quicker rate cut, while Kansas City Fed President Jeff Schmid and Chicago Fed President Austan Goolsbee have expressed caution about cutting rates, fearing that hasty actions could exacerbate inflation.

The unexpectedly strong economic data, along with public disagreements among Fed officials on the rate cut trajectory, make the Fed's October meeting decisions more challenging to predict.

According to Morningstar, traders initially expected the Fed to cut rates up to six or seven times by October next year, but these expectations have now diminished.

This change in expectations is also reflected in the bond market. On Thursday, U.S. Treasury yields rose across the board, with the benchmark 10-year yield climbing to around 4.2% during the session, indicating a possible investor preference for riskier, higher-yield assets. Analysts note this is because investors anticipate that the labor market's weakness is unlikely to worsen significantly and translate into broader economic softness, thereby forcing the Fed to continue cutting rates.

Morningstar analysis points out that although overall monetary policy still points towards further easing, the pace of rate cuts remains unclear. The state of the labor market and inflation data in Q4 may determine the next steps.