The upward revision of U.S. gross domestic product (GDP) growth in the second quarter has led to a reevaluation of expectations regarding the Federal Reserve’s upcoming rate cut. The market, previously anticipating a substantial 50-basis-point cut next month, is now leaning towards a smaller reduction.
This shift comes as investors await the release of the Personal Consumption Expenditure (PCE) price index, the Fed’s preferred inflation gauge, scheduled for Friday morning. The U.S. economy grew at an annualized rate of 3% in the second quarter, according to the government’s revised estimate, up from the initial projection of 2.8%. This increase was driven primarily by robust household spending, which was also revised upward from 2.3% to 2.9%. This strong GDP performance, coupled with recent jobless claims data indicating a healthy labor market, has tempered traders’ expectations for a larger rate cut.
The market-implied probability of a 50-basis-point rate cut has dropped to 32%, down from 38% the previous day, based on the CME Group’s FedWatch tool. Conversely, the likelihood of a smaller 25-basis-point cut has risen to 68%. Looking ahead to the Federal Open Market Committee meeting on November 7, the market’s expectations are evenly split between a 25-basis-point and a 50-basis-point rate cut. Overall, market participants are pricing in a total of 87 basis points in rate cuts by the end of the year, indicating at least three consecutive 25-basis-point reductions.
Ed Yardeni, president of Yardeni Research, described the market’s recent performance as “a Roaring 2020s kind of day,” highlighting the Dow Jones Industrial Average’s record high and the broader market’s gains. He pointed to a robust jobs market, rising real wages, increased productivity, and record corporate profits and cash flow as supportive factors for the ongoing bull market.
Wall Street economists, as tracked by TradingEconomics, anticipate the headline PCE annual inflation rate to rise from 2.5% in June to 2.6% in July, ending a three-month streak of declines. On a monthly basis, the headline PCE is expected to increase by 0.2%, up from 0.1% in June. Core PCE inflation, excluding volatile food and energy prices, is projected to climb from 2.6% to 2.7% annually, with a steady monthly increase of 0.2%.
A PCE report exceeding expectations could strengthen the U.S. dollar index, potentially leading to a rise in Treasury yields and a decline in bond prices. Conversely, a lower-than-expected PCE reading could provide further support for equities. The outcome of the PCE report will play a crucial role in shaping the Fed’s future policy decisions and influencing market sentiment.
