What's really priced in for the Federal Reserve decision
The numbers are all over the place
Many market participants have come to rely on two tools to gauge the likelihood of a Federal Reserve interest rate cut. At the moment, they're sending wildly diverging signals.
The CME Fedwatch tool is showing a 27.3% chance the Fed does nothing today. Yesterday it rose as high as 52%.
The other is the WIRP function on Bloomberg and that's showing a certainty of a cut with a 14% chance of a 50 bps move. That also fluctuated significantly. Last Friday it showed only a 97% chance of a cut with a 3% chance of 50 bps.
Both are sending misleading signals. The problem is that they're priced off short-term interest rate futures and that market has gone wonky lately. Effective Fed funds was 2.30% today from 2.14% at the start of the week.
The market is reflecting some chance that continues or that the Fed stomps it down to the lower end of the range. The October Fed funds contract is trading at 1.89% right now, which is 1.5 bps above the midpoint of 1.75-2.00%. That's exactly 25 bps below Friday's Fed funds level.
So the short story is that the market is using the same instrument to price the Fed outcome and the whether the Fed will actually be successful and that's skewed the signal.
So what's priced in?
At this point it's more art than science but I defer to what was priced in on Friday before the funding market fell apart. That puts a cut at about 97% with a fractional chance of no move. You can argue that Saudi Arabia boosted the chance of a deeper cut but higher oil prices are also inflationary so perhaps the geopolitical risks balance out.
What's more interesting is what's priced in for October and that is a 50/50 probability right now and signals on that will dictate the market's response.