Signs of Weakness in the US Economy Raise Concerns, Bond Traders Betting on the Fed to Take More Aggressive Easing Measures

According to the Wisdom Financial APP, bond traders preparing for the Federal Reserve to gradually cut interest rates starting in September are increasing their bets to guard against a sudden downturn in the U.S. economy forcing the Fed to take more aggressive measures. Traders have fully digested expectations of at least two 25 basis point rate cuts this year, slightly higher than the forecasts in the policymakers' dot plot released earlier. In the derivatives market, some traders are going even further, betting that the Fed will boldly cut rates by 50 basis points in September or start cutting rates even earlier.

While this is still an outlier, there is evidence that both businesses and consumers are feeling the pressure of the highest benchmark rates in 20 years, fueling speculation about the necessity of taking (substantial rate cuts). Despite inflation gradually moving towards the Fed's 2% target, investors are increasingly concerned that the labor market is on the verge of collapse - a factor closely watched by Fed officials. The significant time gap between the July and September policy meetings implies increased risks.

Jack McIntyre, portfolio manager at Brandywine Global Investment Management, said, "If the labor market shows more signs of weakness, the U.S. economic conditions will worsen, prompting the Fed to cut rates further." "What we don't know is what kind of rate-cutting cycle this will be."

Last week, former New York Fed President William Dudley and renowned economist Mohamed El-Erian both stated that keeping rates too high for too long could be a mistake for the Fed. Dudley even called for action at this week's policy meeting, heightening investors' anxiety to new levels.

Just this comment alone was enough to stir the market, causing policy-sensitive short-term U.S. Treasury yields to plummet in what is known as a "bull steepening" pattern before a Fed easing cycle. Nevertheless, macro data on U.S. initial jobless claims, economic growth, and consumer spending provided support for the Fed to stand pat at this week's meeting. Michelle Girard, U.S. head at Natwest Markets, said these data "eliminated the urgency for the Fed to act," and "the Fed does not want to appear panicked."

Expectations of an imminent rate cut by the Federal Reserve have overall boosted US Treasuries, pushing yields significantly below the peak set at the end of April - despite recent concerns over the US presidential election causing some turbulence. The Bloomberg US Treasury Index hit a two-year high this month and is expected to see a third consecutive monthly increase by the end of July.

Data released last Friday showed that the inflation indicators favored by the Federal Reserve rose at a moderate pace in June. The other side of the Federal Reserve's dual mandate - full employment - will be crucial in the coming months, including the US non-farm payroll report for July to be released next week.

George Catrambone, Head of Fixed Income at DWS Americas, stated that signs of a significantly weakened job market "may trigger a new round of questioning about a soft landing for the US economy and raise concerns that the Federal Reserve may be behind the curve, missing the opportunity to cut rates in July."

As the market widely expects the Federal Reserve to stand pat at this week's policy meeting, Federal Reserve Chairman Powell may use the press conference following the rate decision announcement to signal economic concerns or policy adjustments. If the signals he releases begin to lay the groundwork for a larger rate cut than expected, it would send a chilling message, as the Federal Reserve only cut rates by 50 basis points after the bursting of the dot-com bubble in 2001 and the outbreak of the financial crisis in September 2007, followed by a subsequent period of significant easing.

However, according to Michael Feroli, Chief US Economist at Morgan Stanley, this scenario is unlikely. In a report released last Friday, he stated that Powell is expected to "avoid specifying the exact timing of the first rate cut," and when asked about not cutting rates this month, Powell may say that central bank officials want to see further evidence of progress on inflation.

Strategist Edward Harrison said, "Bullard recently advocated for a rate cut at the July policy meeting, indicating a shift in sentiment. Suddenly, everyone is not thinking about inflation, but about the rise in the unemployment rate."

George Goncalves, Head of US Macro Strategy at MUFG, believes that by September, there will be more signs of a weakening US economy, which may prompt the Federal Reserve to take preemptive measures. He said, "Based on the current data, the idea of a slow and steady rate cut makes no sense. The longer they wait, the more they will have to do later."

Some market participants believe that there is enough uncertainty in the market to warrant precautionary bets. In recent weeks, traders have prepared for potential scenarios using options related to secured overnight rates, such as betting on a 25 basis point rate cut by the Federal Reserve as early as July, or a 50 basis point cut in September. Ed Al-Hussainy, Rate Strategist at Columbia Threadneedle Investment, said, "When a 25 basis point rate cut is fully priced in, you only have two choices, 0 or 50 basis points."

![12.png](https://img.zhitongcaijing.com/image/20240729/1722210000765835.png? LH Meyer's economist Derek Tang from the Washington policy analysis company stated that "the macro situation currently does not require, and even does not prove" rapid easing is reasonable. He believes that the Federal Reserve is more likely to choose to cut interest rates by 25 basis points at each meeting (or 50 basis points per quarter), and then try a move of cutting rates by 50 basis points. Ed Al-Hussainy also believes that the Federal Reserve's shift from being on hold for over a year to suddenly cutting rates by 50 basis points would "mean that something not so good has happened."