The speculation surrounding a potential rate cut by the Federal Reserve as early as July has intensified recently, despite current market expectations suggesting it’s unlikely. According to the Chicago Mercantile Exchange’s FedWatch Tool, the probability of a rate cut next month stands at only 12.4%.
However, significant activity in the federal funds rate futures market has drawn attention on Wall Street. Two large bets have been placed recently, both boldly predicting a rate cut in July, contrary to existing market predictions for later rate cuts.
These positions are concentrated in the August federal funds rate futures contract, which expires on August 30th and thus reflects expectations for the July 31st policy decision without being influenced by the results of the September meeting.
One notable transaction involved the purchase of 55,000 contracts, where each basis point movement in interest rates could impact gains or losses by $2.3 million. This leverage means that even a slight shift in market expectations towards a July rate cut (equivalent to around 12.5 basis points) could yield profits of approximately $28 million.
Another similar transaction last week also demonstrated considerable interest, with each basis point movement potentially affecting gains or losses by $1.25 million.
The open interest in the August federal funds rate futures contract has surged to historically high levels, exceeding 400,000 contracts. This indicates active speculation among market participants, despite the prevailing view that the chances of a July rate cut are slim.
Regarding timing, any significant policy shift by the Federal Reserve would typically be communicated in advance to market participants. Federal Reserve Chairman Jerome Powell’s testimony before the Senate Banking Committee on July 9th could potentially serve as a catalyst for shifting rate expectations, following the release of the June nonfarm payrolls report and just days before the release of June’s Consumer Price Index.
Traders have been adjusting their views on Fed policy in recent weeks, closely monitoring economic data reports and policymakers’ speeches. Pricing in the interest rate markets currently suggests traders expect two rate cuts by the Fed this year, whereas the Fed’s June dot plot indicates expectations for only one rate cut.
Ultimately, whether the Federal Reserve decides to cut rates in July will depend on further economic data showing signs of weakening and downward pressure on inflation. Recent economic indicators, such as disappointing jobless claims and a decline in new housing starts, have contributed to growing expectations for Fed easing.
Given the global trend of central banks easing monetary policy, including recent actions by the Bank of England and the Swiss National Bank, there is speculation whether this global shift could influence the Federal Reserve to act sooner rather than later. However, definitive decisions will hinge on the Fed’s assessment of domestic economic conditions and inflationary pressures closer to their upcoming meetings.
