Uncertainty has suddenly increased, the extent of the Fed's rate cut next week becomes a "mystery"!

As the Federal Reserve prepares to cut interest rates for the first time in over four years, investors have significantly increased their bets on a 50 basis point rate cut next week.

Traders in the swaps market are currently pricing in a 45% chance of a significant rate cut by the Fed at the September meeting to prevent economic damage from high rates. In comparison, this probability was only 15% on Thursday.

Expectations of traders on the magnitude of the Fed's rate cut next week

Mark Dowding, Chief Investment Officer of BlueBay Asset Management, a top global asset management firm under Royal Bank of Canada, stated that the likelihood of a 50 basis point rate cut is now "very high," while this expectation was once "almost completely ruled out" on Thursday. The market still believes there is a 55% chance of a small 25 basis point rate cut, but this has cooled significantly compared to Thursday.

On Thursday evening, both the Financial Times and the Wall Street Journal reported that the Fed is facing a difficult decision between a 50 basis point or 25 basis point rate cut. Former New York Fed President Bill Dudley later wrote that he believes there are "strong reasons" to cut rates by 50 basis points next week, emphasizing the restrictive impact of the current policy rate of 5.25% to 5.5% (a 23-year high) on growth.

The Fed typically adjusts rates by 25 basis points, but if officials believe there is a risk of the economy slowing too quickly, a 50 basis point rate cut can be a preemptive measure.

Previous meeting minutes indicated that some officials believed the Fed's rate cut at the July meeting was "appropriate," suggesting that with further declines in inflation thereafter, a larger rate cut could help the Fed catch up.

Tim Duy, Chief U.S. Economist at SGH Macro Advisors, stated: "For the Fed, the least regrettable action is to raise rates by 50 basis points first. This is the only logical policy choice."

Next Wednesday's Fed meeting is the last one before the November presidential election for Harris and Trump, and as officials attempt to guide the world's largest economy towards a "soft landing," this meeting is under intense pressure. A soft landing refers to curbing inflation without causing an economic recession.

Analysts say this meeting is one of the most uncertain in years, as recent data shows a mixed outlook for the U.S. economy, with lingering price pressures and some weakness in the labor market.

This week's CPI data showed that overall inflation fell to 2.5%, close to the Fed's 2% target, but core inflation rose 0.3% month-on-month, higher than expected, partly due to pressures in the real estate market.

Wylie Tollette, Chief Investment Officer at Franklin Templeton Investment Solutions, believes, "If inflation in the housing sector persists, a 50 basis point rate cut could actually accelerate or amplify this situation." He expects the Fed to cut rates by 25 basis points next week, adding that the upcoming election could complicate the prospects for a significant rate cut Trump has previously stated that a rate cut by the Federal Reserve would help Harris become the current Vice President, "even though they know they shouldn't do that."

Tollette said: "The Fed's path is that they want to do the right thing for the economy, I don't think they want to be seen as favoring the current candidate through more aggressive rate cuts."

However, as unemployment rises and demand slows, Fed officials hope to prevent further weakness in the labor market. Fed Chairman Powell said last month that they will "make every effort to support the labor market when progress is made on price stability."

Salman Ahmed, Global Head of Macro at Fidelity International, said: "This is a cat-and-mouse game. We are about to start a rate-cutting cycle, but much remains to be determined." He added that in the majority of the time after the COVID-19 pandemic, "it is clear that both the market and the Fed do not know what they will do."

In December last year, the Fed predicted a 75 basis point rate cut by 2024, but by June, it stated that it would only cut rates by 25 basis points this year