A rate cut by the Federal Reserve in September seems nearly inevitable as signs of a cooling job market bolster expectations for monetary easing. Bond traders, who previously grappled with forecasting the peak of the Fed’s tightening cycle, now face a similarly challenging task in predicting the pace and extent of rate cuts. The market consensus points toward a more aggressive path of rate reductions than the Fed has currently signaled.
However, the bond market may have overreached, anticipating a swift and deep easing cycle even as the U.S. economy continues to expand, albeit at a slower pace. This disconnect between market expectations and the Fed’s potential actions underscores the stakes for investors as the U.S. central bank prepares for its first rate cut since 2020 at its September 18 meeting. The mere anticipation of this move has already driven bond prices sharply higher, as traders position themselves ahead of the Fed’s actions. This preemptive surge in bond prices carries the risk of market dislocations, especially in an economy that has repeatedly defied post-pandemic expectations.
Market participants currently place the highest probability on the Fed reducing its target rate—currently set at 5.25% to 5.5%—by a quarter of a percentage point this month. However, should the Fed opt for a more aggressive approach, such as a 50-basis-point cut, it could significantly loosen financial conditions, raising the risk of a resurgence in inflationary pressures.
Adding to the market’s uncertainty, the Labor Department is expected to report on Wednesday that the Consumer Price Index (CPI) rose by 2.6% year-over-year in August, according to the median forecast of economists. This would mark the smallest annual increase since 2021. As the Fed enters its traditional blackout period ahead of the September 17-18 meeting, investors will receive little additional guidance, heightening the focus on this upcoming inflation data to gauge the central bank’s next steps.