Just about everyone predicted the Federal Reserve would cut interest rates on Wednesday. But the market is no longer sure.
According to the CME’s FedWatch Tool, which measures what the markets are predicting the Fed will do next, the probability of a quarter percentage point rate cut is only 56%, down from 92% just over a week ago.
Translation: Investors are split on whether the Fed will cut rates.
An even more dramatic half percentage point cut, which was forecast by some this summer, is no longer even considered an option.
The context: This drastic change of heart comes after several turbulent days.
On Monday, oil prices skyrocketed after Saudi Arabian oil facilities were attacked, sparking worries about global oil supply. Higher oil prices can lead to inflation.
The United States and China also agreed to delay tariffs and return to the negotiating table, which removed some uncertainty.
On top of that, investors are keeping a close eye on economic data, and whether it is flashing a warning light for the economy. American consumer spending has so far outweighed a slow down in manufacturing.
Political concerns: President Donald Trump has put the central bank under immense pressure to cut rates. The latest salvo came Monday via social media.
“Will Fed ever get into the game? Dollar strongest EVER!” Trump said on Twitter. “Big Interest Rate Drop, Stimulus!”
A crack in the financial markets
The New York Federal Reserve is running a special operation aimed at reducing short-term interest rates and easing stress in financial markets.
On Tuesday morning, the NY Fed launched what’s called an “overnight repo operation,” during which the central bank attempts to ease pressure in markets by purchasing Treasuries and other securities.
More action: Phase two will take place before markets open on Wednesday, when the NY Fed will conduct a second operation aimed at repurchasing up to an additional $75 billion.
The goal is to pump money into the system to keep borrowing costs from creeping above the Fed’s target range. The episode demonstrates evidence of emerging strains in financial markets and raises concern that the Fed could be losing its grip on short-term rates.
“The funding markets are clearly stressed,” said Guy LeBas, managing director of fixed income strategy at Janney Capital Markets. “It’s going to require Fed action.”
Kit Juckes, a strategist at Societe Generale, described the situation as a “plumbing disaster.”
“This is much more a plumbing problem caused by a sharp change in Treasury supply/demand dynamics than a symptom of fundamental threat to the system or the global economy,” he said. “It will be interesting to see what Fed Chairman Jay Powell says about the mess.”