How many Fed rate cuts does the market ‘expect’? – Commerzbank

The US labor market report on Friday did not come as a clear surprise on the negative side. As a result, there was no clear market reaction, but rather a fair amount of back and forth before equilibrium was established. The fact that this was slightly below the levels before the BLS publication is not particularly revealing. What is important is that, at current levels, visible USD-negative surprises are needed to weaken the Greenback further. A self-sustaining momentum towards further USD weakness, regardless of the figures, can no longer be discerned at current levels — unlike much of August, when USD weakness was virtually a foregone conclusion, Commerzbank’s Head of FX and Commodity Research Ulrich Leuchtmann notes.

Less than 100 basis points is not necessarily USD-positive

“Market expectations for the Fed's interest rate policy in the near future are already quite extreme. More than 25 basis points of interest rate cuts are priced into the Fed's decision next week. And more than 100 basis points by the end of the year. Now, there may be early signs that the US labor market is weakening. But it seems courageous of the market to bet so heavily that this trend will become so dramatically more visible before the end of this year that the Fed will at least cut rates by 50 basis points at one of its remaining three meetings in 2024.”

“One should not be deceived by the word ‘market expectation’. A market expectation does not indicate what the market is most likely to anticipate. The typical investor is in the unpleasant position of having to book losses on many of his assets: Stocks are likely to perform poorly, the value of one's own home would be less and worries about one's own job would reduce the risk-adjusted future labor income. It therefore makes sense to bet on a US recession in the Fed Funds Futures market to an extent that significantly exceeds the probability of it occurring.”

“In other words, especially in a situation in which a US recession is not all that likely, but also not so unlikely that this scenario can be ignored anymore, the risk premiums in the fed funds futures market are certainly huge. The above figure does not therefore mean that the average market participant expects more than 100 basis points of Fed rate cuts by year-end. Consequently, if it is less than 100 basis points, this is not necessarily a USD-positive argument.”