Traders Anticipate Nearly Three Rate Cuts from Fed by Year-End

Traders are now factoring in nearly three rate cuts from the Federal Reserve by the end of 2023, driven by a blend of economic indicators that suggest a softening labour market. The latest data reveals that initial jobless claims have reached their highest level since October 2021, signaling potential weakness in employment. This shift in the job market is contributing to a growing consensus among traders regarding the Fed’s monetary policy trajectory.

The focus on the US Consumer Price Index (CPI) report, released recently, highlighted that while inflation remains a concern, the figures were not alarming enough to deter market expectations. The monthly headline inflation rate was reported at 0.4%, with core inflation coming in at 0.3%. Notably, the core inflation figure was marginally below expectations, with an unrounded value of 0.346%, indicating a close call in terms of meeting inflation targets.

Traders are increasingly aware that the inflation rates are still above the 0.17% monthly increase required for annual inflation to align with the Fed’s 2% target. With the impact of tariffs likely to continue influencing prices in the upcoming months, persistent inflationary pressures are anticipated, at least until the year’s end.

Inflation Drivers and Market Reactions

The recent CPI report indicates that headline inflation has been significantly influenced by rising energy prices, which increased by 0.7%, and food prices, which rose by 0.5%. Core prices saw a notable jump, largely due to a 5.9% surge in airfares, coupled with a 1.0% increase in used vehicle prices. Additionally, the apparel sector, particularly sensitive to tariffs, experienced a price hike of 0.5% in August, reflecting the ongoing effects of import tariffs.

Despite these inflationary signals, market sentiment has not turned overly pessimistic. Many analysts suggest that a slowing job market could ultimately lead to reduced price pressures, counteracting the temporary inflation effects attributed to tariffs. This perspective has led traders to adjust their expectations, now anticipating approximately 71 basis points of rate cuts by the end of the year, up from an earlier estimate of 67 basis points prior to the release of the latest economic data.

Looking ahead, the prospect of a significant 50 basis point rate cut in the upcoming Federal Reserve meeting appears unlikely. Nevertheless, market participants are increasingly convinced that the Fed will need to implement consecutive rate cuts before the year concludes to address the evolving economic landscape.

As the Fed prepares for its next steps, the interplay between a weakening labour market and persistent inflation will be pivotal in shaping monetary policy decisions in the months ahead.