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Traders expect the Federal Reserve to cut interest rates significantly this week to become more likely.
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With markets pricing in the increasing likelihood of a 50 basis point rate cut, the Fed is more likely to follow through, BMO’s Ian Lyngen said.
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He says markets that are pricing in an 80% chance of a big rate cut could influence the Fed. The chance is currently 63%.
Investors have been pricing in an increasing chance of a 50 basis point rate cut by the Federal Reserve.
And now that the market is increasingly preparing for a drastic rate cut, the Fed is more likely to take action, said Ian Lyngen, head of U.S. rates strategy at BMO.
“While we are still in the 25 basis point camp, we have to admit that the more aggressive market prices are at 50 basis points, the more the Fed will feel compelled to push through such a move,” Lyngen said in a note on Monday.
According to CME’s FedWatch tool, markets were pricing in a 63% chance of a 50 basis point rate cut on Tuesday afternoon, compared to a 37% chance of a 25 basis point rate cut.
Investors believe the odds of a bigger move have nearly doubled from last week, when the market was expecting just a 34% chance.
According to Lyngen, there needs to be an 80% chance before the Fed is convinced to make a large initial cut in the benchmark rate.
“I suspect that as we go into the event with a probability of more than 80% of 50 [basis points]“There is a good chance that they will take 50 steps to speed up the process,” Lyngen said in an interview with Bloomberg Surveillance on Tuesday.
Some analysts have said the Fed needs to cut 50 basis points to ease policy quickly amid a cooling labor market. Others have said such a deep initial cut would likely spook markets and trigger a selloff on recession fears.
Lyngen stressed the dour nature of the Fed’s communication, but said the central bank will likely seek a more neutral stance regardless of whether it makes a small or large cut.
“This is a tricky issue for the Fed from a communications perspective,” Lyngen said.
He also noted that there is a chance of discord within the Fed. If that were the case, it could further ease market concerns about the state of the economy in the event of a massive rate cut.
“There is nothing to suggest that everyone should vote for 25 or 50. So I think this could be another way to communicate to the market that it was a knife-edge decision and that it is uncertain how to proceed,” Lyngen said.
The Fed will announce its decision at 2 p.m. Eastern Time on Wednesday.
Read the original article on Business Insider
