As President Donald Trump’s trade war escalates, concerns about a potential U.S. recession are growing. This has led to mounting pressure on the Federal Reserve (Fed) to cut interest rates, with analysts now betting on more significant rate cuts than anticipated.
Bloomberg reported on Tuesday that options prices tied to the Fed’s Secured Overnight Financing Rate (SOFR) reflect a higher likelihood of multiple rate cuts by the end of the year. At market close, expectations pointed to about 80 basis points (bps) in rate cuts by year-end, up from 60 bps just a week ago. This shift suggests that market participants now anticipate that the Fed will lower rates by 25 bps at least three times, effectively adding rate cuts to their projections in just a week.
Although market participants aren’t expecting any rate cuts until June, Bloomberg notes that options traders anticipate increasing pressure on the Fed to implement cuts in the coming months to help stimulate the economy.
According to the CME FedWatch Tool, as of today, the probability of a 75-basis-point rate cut by the end of December has risen to 34.7%, a significant jump from 11.7% just a week ago. Meanwhile, the likelihood of a 50-bps rate cut remains relatively unchanged at 28.1%, down slightly from 28.6% last week.
The options market linked to potential rate cuts is expected to be tested by Wednesday’s Consumer Price Index (CPI) release. The current market expectation is for a 2.9% year-over-year increase. Federal Reserve Chairman Jerome Powell has consistently stated that he will not rush monetary policy decisions until the full effects of policy changes under the Trump administration become clearer.
In a speech at a monetary policy forum in New York on March 7, Powell said, “We do not need to be in a hurry, and are well positioned to wait for greater clarity,” He explained that the new administration is pursuing significant changes in four key areas: trade, immigration, fiscal policy, and regulation. “It is the net effect of these policy changes that will matter for the economy and for the path of monetary policy,” Powell emphasized.
He also noted that there has been progress in some areas, including trade policy, but uncertainty remains regarding the potential impacts of these policy changes. Powell concluded by saying that as they analyze new information, they focus on distinguishing signals from noise as their outlook evolves.