As Federal Reserve Chairman Jerome Powell tries to explain what’s likely to be the central bank’s first rate cut in more than a decade on Wednesday, it won’t take much for the market to get even more aggressive and ask for additional easing sooner.
The swaps market shows traders pricing in nearly three 25-basis-point cuts by January, and another quarter-point reduction by the end of 2020.
But if Powell focuses on the downside risks — U.S.-China trade tensions and global economic weakness among them — while moving away from being dependent on domestic data, markets will probably count on that fourth cut happening sooner, according to Deutsche Bank U.S. rates strategist Steven Zeng.
“The market has made up its mind for at least the next several months that the Fed should cut by more than 25 basis points to offset the potential risks,” he said in an interview.
“Depending on the Fed’s messaging — the statement and Powell’s tone — and if it’s kind of dovish, the market will push for more this year and assign a higher probability of a fourth cut sooner in 2020,” Zeng explained.
Deutsche Bank strategists’ primary concern is that markets will interpret any message about further rate cuts being data-dependent as “hawkish.”
Zeng sees a better-than-50% chance of a more dovish outcome that brings forward the pricing of the fourth rate cut and reaffirms Deutsche Bank’s expectation for three 25-basis-point cuts this year.
–With assistance from Edward Bolingbroke and Mark Tannenbaum.