Markets now expect the Fed to lower rates again in October

Markets now expect the Fed to lower rates again in October, with the CME FedWatch Tool showing a 91.9% chance of a second consecutive cut.

This follows the quarter-point reduction last week, which was the first time the central bank had eased rates since December. The latest bets reflect Wall Street’s strong belief that the Fed, under growing pressure, is on track to deliver more easing as the economy shows signs of cooling off.

This shift comes ahead of a key inflation reading due Friday — the August personal consumption expenditures (PCE) index. The number is expected to land at 2.8%, which matches the Fed’s annual target. But if it overshoots, even by a little, it could trigger worries that last week’s cut came too early.

That would add fuel to fears the Fed might have opened the door for inflation to dig back in. The stakes are high. A clean 2.8% would justify the recent decision. Anything higher, and people will start asking if the central bank got played.

Bond yields rise while stocks climb anyway

Instead of falling, yields on 10-year and 30-year Treasurys climbed after the cut, which caught a lot of people off guard. Yields normally react to rate decisions in a straight line: lower rates, lower yields. But that didn’t happen.

This time, bond traders looked past the cut and fixated on the broader picture — like the U.S. government’s ballooning debt and erratic fiscal policy. Rising yields suggest that the bond market isn’t buying the idea that the economic backdrop justifies this pivot from the Fed.

On the equity side, no such hesitation. Investors pushed the S&P 500 and Dow Jones Industrial Average to new highs on Friday. Meanwhile, the Nasdaq Composite jumped 2.2% over the week.

For now, the stock market’s verdict is simple: cheaper borrowing is good, and they’re not waiting around for inflation reports to tell them otherwise. They already moved.

Traders are now positioning for two more cuts by the end of 2025. The bets are clear, but nobody’s pretending there’s no risk. “With equities near the highs and rates markets still pricing in roughly five additional cuts over the next year, further support for equities will hinge more on robust incoming macro data than on more dovishness in rates, in our view,” said Emmanuel Cau, head of European equity strategy at Barclays.

In other words, don’t expect the rally to last if the data doesn’t.

Investors hedge risks as Fed bets grow

Not everyone’s convinced this market is fully priced in. Henry Allen, a strategist at Deutsche Bank, doesn’t think it’s even close. “On several metrics that clearly isn’t the case,” Henry wrote in a note to clients. “Yes, there’s been a remarkable strength and resilience to risk assets over recent years, but markets are well alive to downside risks too, hence we have gold prices at a record high and rapid Fed rate cuts priced in.”

Henry also pushed back on the narrative that we’re heading for another dot-com-style bust. While there are surface-level similarities, he said the conditions of the late 1990s, the ones that screamed tech bubble, aren’t showing up today. That means investors are cautious and calculating, watching both inflation and the Fed like hawks.

Outside the U.S., China is taking a very different path. On Monday, the People’s Bank of China held its benchmark lending rates steady for the fourth month in a row, despite the Fed’s move last week. The one-year loan prime rate stayed at 3.0%, while the five-year rate, the one that steers mortgage costs, held at 3.5%.

Unlike Washington, Beijing hasn’t blinked. Its last move was back in May, when both rates were cut by 10 basis points to help shore up the slowing Chinese economy. Since then, not a single adjustment. While the Fed is reacting to soft labor numbers and sticky inflation, China’s banking officials seem content to hold their line.

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