Fed rate cut divergence difficult to eliminate Market focus shifts from non-farm to inflation data, election debate

According to the Zhitong Finance and Economics APP, as traders focus on the U.S. inflation data to find further clues on the extent of the Fed's interest rate cut this year, U.S. Treasury prices fell.

The yield on the two-year Treasury, which is most sensitive to changes in policy outlook, rose by 6 basis points to 3.71%, while the yield on the 10-year Treasury climbed by 5 basis points to 3.76%. Currently, traders have reduced the probability of a 50 basis point rate cut by the Fed at the upcoming September meeting from as high as 51% last week to 25%.

Despite last Friday's U.S. labor market data showing signs of cooling economic growth, policymakers' subsequent comments did not provide clear reasons for a significant rate cut. Fed Governor Bullard echoed Chairman Powell's remarks that it is time to start cutting rates, but he emphasized that the size and speed of the rate cut will depend on the upcoming economic data.

Elias Haddad, Senior Market Strategist at Brown Brothers Harriman, mentioned that the U.S. CPI report for August, scheduled to be released on Wednesday, will help determine the extent of the Fed's rate cut decision in September. Higher-than-expected U.S. inflation could reduce the likelihood of a significant rate cut by the Fed.

According to a survey, the U.S. Consumer Price Index for August is expected to rise by 2.6% year-on-year, the lowest level in three years.

In recent weeks, there has been a divergence in the market regarding whether signs of stabilizing inflation and deteriorating employment data will prompt the Fed to initiate a 25 basis point rate cut or a larger easing measure. Investors are uncertain about what will happen next and whether the Fed will cut rates significantly or take a more gradual approach.

Steven Major of HSBC believes that the market is far from being at a loss in terms of rate cut expectations. The Fed may cut rates by up to 300 basis points until reaching a new equilibrium level, a possibility that the market has not fully digested yet.

The Global Head of Fixed Income Research at HSBC stated, "The market pricing may not fully reflect this." He added that from a long-term perspective, a 300 basis point rate cut is "reasonable." Major, who is bullish on U.S. Treasuries in the long term, expressed a preference for long positions in U.S. Treasuries.

However, in addition to the question of how large the Fed's rate cut will be, traders may also need to address other issues In addition to the inflation report, attention has also turned to the U.S. presidential debate between Harris and Trump on Tuesday. Prior to this, President Biden's disastrous performance had boosted Trump's approval ratings, providing support for the U.S. dollar. On Monday, the U.S. dollar index rose by 0.4%, and the dollar strengthened against most currencies in the G10 group.

Chris Turner, director of foreign exchange strategy at ING Group, said, "The August U.S. employment report failed to resolve the debate over whether the Fed will cut interest rates by 25 basis points or 50 basis points on September 18. As for the trend of U.S. bonds, one of the biggest market drivers this week may be tomorrow night's U.S. presidential debate."