Expectations for interest rates among major central banks show a tendency towards rate cuts by the end of the year. The Federal Reserve is expected to cut rates by 59 basis points, with a 93% probability of a rate cut at the upcoming meeting.
The European Central Bank shows a 14 basis point reduction expectation, with a 92% probability of no change soon. Meanwhile, the Bank of England might cut rates by 49 basis points, with a 96% chance of this happening. The Reserve Bank of Australia has the highest expected rate cut at 65 basis points, with a 99% certainty of a cut.
The Bank Of Japan Outlook
In contrast, the Bank of Japan is expected to increase rates by 13 basis points, maintaining a 92% probability of no change for the next meeting. The changes in expectations for the Federal Reserve have influenced other central banks due to the impact of the US economy on global markets.
There is an expectation for at least two rate cuts by year-end, with some considering the possibility of a third. The market originally expected 35 basis points of easing before the NFP report, which revised these expectations to 59 basis points of cuts.
A dovish repricing has swept through the markets following the latest Non-Farm Payrolls report. The report, which showed the US economy adding only 95,000 jobs in July, was much weaker than expected. This has led to a significant shift in expectations for central bank actions.
Recent Market Reactions
We now see 59 bps of Fed cuts priced in by the end of the year, a sharp jump from just 35 bps before the jobs report. With June’s CPI inflation having cooled to 2.8%, the market is assigning a 93% chance of a rate cut at the September meeting. This implies the market is now confident we will see at least two cuts before 2026.
This sentiment has spilled over globally, as is often the case when the Fed’s path changes. We are now seeing aggressive easing priced in for the Bank of England (49 bps) and the Reserve Bank of Australia (65 bps). Both are now highly expected to cut at their next meetings.
We believe the market may have overreacted to a single NFP print, creating a potential opportunity. This is reminiscent of periods in 2023 when traders prematurely priced in policy pivots that didn’t happen as quickly as anticipated. A strategy for the coming weeks could involve watching for any signs of economic resilience that would challenge this new dovish narrative.
Derivative traders could consider strategies that benefit if this dovishness fades. This might involve looking at options on interest rate futures that would pay off if the market pulls back its expectation of a third cut. If economic activity rebounds after an initial rate cut, this mean-reversion trade could be profitable.
