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Bond traders who\u2019ve set themselves up for gradual interest-rate cuts starting in September are ramping up side bets in case a sudden slide in the US economy forces the Federal Reserve to be even more aggressive.<\/p>\n
As Treasuries advance for a third-straight month, investors are fully pricing in at least two quarter-point rate reductions this year, slightly more than what policymakers have telegraphed. In the derivatives market, some traders have gone even further with wagers that pay off if central bankers go bold and deliver\u00a0a half-point cut<\/a>\u00a0in mid-September \u2014 or start lowering rates sooner.<\/p>\n While still an outlier scenario, speculation around the need for such a move has gained traction amid evidence that\u00a0companies<\/a>\u00a0and\u00a0consumers<\/a>\u00a0are feeling the pinch from two-decade-high benchmark rates. Even as inflation has ebbed, investors are increasingly concerned the labor market is about to crack \u2014 something Fed officials said they\u2019ll be attuned to. The sizable time gap between the July policy meeting and September\u2019s adds risk to the equation.<\/p>\n \u201cIt\u2019s fair to say that if labor shows more signs of weakening, then the economy is in worse shape and that gets the Fed to cut more,\u201d said Jack McIntyre, portfolio manager at Brandywine Global Investment Management. \u201cWhat we don\u2019t know is what kind of cutting cycle it will be.\u201d\u00a0<\/p>\n Anxiety reached a new level last week, when former New York Fed President William Dudley and Mohamed El-Erian said the Fed risks making a mistake by holding rates too high for too long \u2014 with Dudley even calling for a move at this week\u2019s policy meeting. Both were writing as\u00a0Bloomberg Opinion<\/a>\u00a0columnists.<\/p>\n The commentary alone was enough to roil the market, sending policy-sensitive short-term US yields tumbling in a so-called steepening pattern, as is customary before an easing cycle. Still, eco-friendly data on jobless claims, US growth and consumer spending helped support the case for the central bank to hold tight this week.\u00a0<\/p>\n The data \u201cremoves the urgency for the Fed to have to act,\u201d Michelle Girard, head of US at Natwest Markets, told Bloomberg Television on Thursday. \u201cThe Fed does not want to appear panicked.\u201d<\/p>\n Anticipation of imminent rate cuts has buoyed Treasuries overall, sending yields markedly lower from peaks set in late April \u2014 despite some\u00a0recent turbulence<\/a>\u00a0sparked by election concerns. A Bloomberg index of US government debt touched a two-year high this month and is poised to end July on a three-month winning streak last seen in mid-2021.\u00a0<\/p>\n Policymakers have left their target rate at 5.25% to 5.5% for a year while awaiting signs of a sustained cooling in inflation. With prices seemingly headed in the right direction \u2014 data released Friday showed the Fed\u2019s preferred measure of inflation\u00a0rose at a tame pace<\/a>\u00a0in June \u2014 they\u2019ve begun placing more emphasis on the other side of their so-called dual mandate: full employment.\u00a0<\/p>\n On that front, the coming couple of months will be crucial \u2014 including next week\u2019s jobs report. Evidence of material weakness \u201cmay bring renewed questions about the soft landing and perhaps the Fed falling back behind the curve and missing the opportunity to have cut rates in July,\u201d said George Catrambone, head of fixed income at DWS Americas.\u00a0<\/p>\n With the Fed widely expected to stand pat, Chair Jerome Powell could use his press conference on Wednesday to raise fresh economic concerns or policy changes.\u00a0<\/p>\n Should he start laying the groundwork for deeper-than-expected cuts, it would send a dire signal: Only in the wake of the dot-com bubble deflating in early 2001 and the onset of the financial crisis in September 2007 did the Fed deliver half-point reductions to initiate what became big easing cycles.\u00a0<\/p>\n JPMorgan Chase<\/a> & Co.\u2019s Michael Feroli doesn\u2019t expect a turn like that. In a note Friday, he said he expects Powell will \u201csteer away from pointing to any specific meeting for the first cut.\u201d As for fielding questions about not cutting this month, Powell could say central bankers want further evidence of progress on inflation, according to the note.<\/p>\n George Goncalves, head of US macro strategy at MUFG, sees more signs of a weakening economy by September possibly prompting a preemptive response from the Fed.<\/p>\n \u201cThis idea of slow and steady cuts makes no sense given how data is shaping up,\u201d Goncalves said. \u201cThe longer you wait, the more you may need to do later.\u201d\u00a0<\/p>\n Some in the market see enough uncertainty to warrant just\u2014in-case bets. Traders in recent weeks\u00a0have used options<\/a>\u00a0linked to the Secured Overnight Financing Rate, which closely tracks Fed policy expectations, to position themselves for long-shot scenarios such as quarter-point moves starting as early as July, or a half-point cut in September.\u00a0<\/p>\n \u201cWhen a 25-basis-point cut is fully priced, you only have two options,\u201d said Ed Al-Hussainy, a rates strategist at Columbia Threadneedle Investment. \u201cYou can position for zero or you can position for 50.\u201d<\/p>\n For now, \u201cthe macro picture does currently not demand or even justify\u201d rapid easing, said Derek Tang, an economist at LH Meyer, a policy analysis firm in Washington. He said officials were more likely to opt for quarter-point cuts per meeting \u2014 or 50 basis points per quarter \u2014 before trying something as drastic as a half-point reduction.<\/p>\n Going from being on hold for more than a year \u201cto suddenly doing 50 means something has hit the fan, and it doesn\u2019t smell good,\u201d said Al-Hussainy.\u00a0<\/p>\n<\/div>\nRecommended Newsletter: <\/strong>CEO Daily provides key context for the news leaders need to know from across the world of business. Every weekday morning, more than 125,000 readers trust CEO Daily for insights about\u2013and from inside\u2013the C-suite. Subscribe Now<\/a>.<\/div>\n