Recession fears, market sell-off raise odds of a bigger Fed rate cut

A growing number of investors are betting that the Federal Reserve will make a super-sized interest rate cut when policymakers next meet in mid-September.

Fears of an impending recession have some Wall Street economists betting that the Federal Reserve will approve an unusually big interest-rate cut when policymakers next meet in September. 

A majority of traders are already pricing in an 84.5% chance of a 50 basis point reduction during the Fed's meeting on Sept. 17-18, according to the CME Group, which tracks trading. Just 15.5% of traders think the Fed will approve a quarter-point cut.

"While we do not think conditions are ripe for the Fed to make an emergency rate cut, the case for a supersized 50 basis point reduction at its next meeting has been bolstered by the recent market turmoil," said Joe Brusuelas, RSM chief economist.

The new projections come on the heels of the disappointing July jobs report, which showed that total nonfarm payrolls grew by just 114,000 in July, while the jobless rate unexpectedly jumped to 4.3%. The report reignited fears of a slowing economy, because it triggered the so-called Sahm rule, an indicator that is used to provide an early recession signal. 

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The rule stipulates that a recession is likely when the three-month moving average of the jobless rate is at least a half-percentage point higher than the 12-month low. 

Over the past three months, the unemployment rate has averaged 4.13%, which is 0.63 percentage points higher than the 3.5% rate recorded in July 2023. The Sahm rule has successfully predicted every recession since 1970.

Stocks plunged on Friday following the report, with the S&P 500 notching its worst day since October 2022. The indexes resumed their downward spiral Monday as the sell-off deepened. The Dow Jones Industrial Average tumbled more than 1,000 points, while the tech-heavy Nasdaq Composite slid 3.43%. The S&P 500 slid another 3%.

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"With the unemployment rate above and core PCE inflation now below the Fed's year-end forecasts, we believe that the balance of risks favors more aggressive action by the Fed," UBS analysts wrote in a Friday note. "We are changing our base case to rate cuts of 50 basis points in September and 25 basis points each in November and December."

The slowdown in job growth has also raised questions about whether the Fed waited too long to cut interest rates, which are currently hovering near a 23-year high. Policymakers voted to hold rates steady during their meeting last week, but they opened the door to a rate cut in September. 

Some investors have also speculated that the Fed will be forced to make an emergency rate cut. The central bank rarely cuts rates outside of regularly scheduled meetings, and has only done so seven times. The most recent emergency cut took place on March 15, 2020, at the onset of the COVID-19 pandemic, when the Fed slashed rates to near zero.

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Chicago Fed President Austan Goolsbee cast doubt that the jump in unemployment and ongoing stock-market volatility is enough to warrant an emergency rate cut.

"We’ve got to be monitoring the real side of the economy: There’s nothing in the Fed’s mandate that’s about making sure the stock market is comfortable," Goolsbee told The New York Times.