Traders see a chance the Fed cuts by a half point

Traders are leaving open the option the Federal Reserve next week could cut its key interest rate by half a percentage point, though most on Wall Street think the bar for doing so is pretty high.

In the most likely scenario being priced in by markets, the Fed on Sept. 17 will lower the overnight funds rate by 25 basis points, or 0.25 percentage point. Odds for a quarter-point cut were around 88% on Monday afternoon, according to the CME Group's FedWatch tool that measures odds of Fed action based on 30-day fed funds futures contracts.

However, that left open a remote chance that the central bank's Federal Open Market Committee still could enact a half-point reduction, as it did at the September meeting in 2024. Chances of that were at 12% as traders disregarded any possibility the committee might stay put.

Market sentiment shifted even more toward Fed easing after Friday's jobs report showed that nonfarm payrolls expanded by just 22,000 in August while the unemployment rate rose to a nearly four-year high of 4.3%.

"The soft August jobs report will help drive consensus across the committee that not only should rate cuts resume this month, but that further cuts will likely be appropriate in coming months," Citigroup economist Andrew Hollenhorst said in a note after the payrolls release.

While Hollenhorst thinks there could be some support on the FOMC for a bigger move, "we do not think the majority of the committee would support a 50 [basis point] cut." Those possibly favoring a larger move include Governors Michelle Bowman and Christopher Waller, as well as Stephen Miran should the Senate confirm him before the Fed convenes.

Citi holds a slightly out-of-consensus view that the FOMC will cut at each of its next five meetings as officials look through the current inflation trends and focus more on weakness in the labor market. The call is predicated on Fed officials continuing to worry about inflation but focusing more on jobs.

"The August employment report solidifies the case for the Fed to deliver a series of insurance cuts at upcoming meetings," Nomura economist David Seif wrote. "With inflation risks elevated, we expect officials would need to see clearer evidence of labor market stress or a sharp tightening in market financial conditions before delivering more aggressive easing."

Current market expectations are that the Fed cuts next week, skips October and lowers again in December.

In the era since FOMC chairs started having news conferences after each meeting — begun in 2019 with current Chair Jerome Powell — it's been rare for the Fed to skip meetings during periods where it was adjusting rates.

However, Apollo economist Torsten Slok said policymakers are in a ticklish spot now with inflation still above target and the soft jobs picture, putting the central bank's dual goals of stable prices and full employment in conflict.

Fed officials will get inflation data later this week on producer and consumer prices, the last major data releases before the meeting. Economists surveyed by Dow Jones expect the all-items inflation rate to rise to 2.9% though core is expected to hold at 3.1%. Higher-than-expected CPI would likely cement the quarter-point move.

"In the worst case, if inflation surprises to the upside, it will really make it tricky, and we could begin to have a discussion about this sense next week," Slok said Monday on CNBC. "Namely, how does the Fed do policymaking when one side of the dual mandate says it should be cutting and the other side says it should be hiking?"

Slok said he still expects the Fed bias to be toward easing even with stubborn inflation.

"I think that they will begin to talk more about inflation expectations and begin to put less weight on current inflation and instead on future inflation," he said.