Wall Street's Big Bet on Jumbo Fed Cuts Hinges on US Jobs Report

Citigroup Inc. and JPMorgan Chase & Co. have made a bold prediction that the Federal Reserve may cut interest rates by half a percentage point this month, a forecast that faces a significant test with the upcoming U.S. jobs report on Friday. Currently, interest-rate swap contracts reflect a roughly 35% chance of such a substantial cut when the Fed meets on September 17-18. However, most traders and economists are still leaning toward a more modest quarter-point reduction, which remains the favored outcome.

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This split between a quarter-point and a half-point cut has increased the potential for both significant gains and losses in the Treasury market, depending on the outcome of the jobs report. Last month’s employment figures missed expectations, which caused volatility in the markets. Now, the upcoming report has the potential to sway market sentiment and clarify the Fed's next move.

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“There’s a lot of uncertainty right now, and it’s likely to be resolved by the end of the week,” said Matthew Raskin, U.S. head of rates research at Deutsche Bank AG. He added that if market expectations shift decisively toward one outcome, bets on a 25-basis-point move could either result in modest gains or steep losses, while those wagering on a 50-basis-point cut would see the reverse.

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Federal Reserve Chair Jerome Powell has made it clear that the state of the labor market will play a central role in determining the timing and extent of interest rate cuts. Market expectations for a larger rate cut grew after data showed weaker-than-expected job openings in July and soft private-sector job growth in August, as reported by ADP.

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Following the release of the jobs report on Friday, the Fed will enter its customary “quiet period” ahead of its policy meeting, during which it refrains from commenting on monetary policy. Historically, there has been only a minor discrepancy—around three basis points—between market expectations at the start of this quiet period and the Fed’s ultimate decision.

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Currently, markets are pricing in about 34 basis points of easing, suggesting that the shift in market sentiment this week could lead to a downward adjustment to around 28 basis points or an upward move to 47 basis points, depending on whether the data favors a quarter-point or half-point cut. The direction the market moves in will likely depend on the clarity of the employment data.

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“There’s a lot of uncertainty around the employment report, the stock market, and what the Fed is going to do,” said Alex Manzara, a derivatives broker at R.J. O’Brien & Associates. He noted that the S&P 500 has dropped more than 2% three times since late July, reflecting the market’s heightened sensitivity to economic data.

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Options on two-year Treasury note futures are being priced with expectations of a roughly 17-basis-point yield change in either direction, depending on Friday's job data, according to Manzara. At the same time, futures linked to the Secured Overnight Financing Rate (SOFR), which is influenced by the Fed’s policy rate, suggest that there is still a degree of market conviction that the central bank could deliver a half-percentage-point cut.

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Currency traders are also showing increased activity ahead of the U.S. jobs report, with options signaling heightened volatility in the dollar against major currencies. In fact, risk reversals—used to measure market sentiment—indicate bearish sentiment toward the U.S. dollar. Many traders are avoiding short-term bets altogether due to the uncertainty surrounding the report.

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Since early August, both Citigroup and JPMorgan have been predicting a half-percentage-point rate cut in September and November, followed by a quarter-point cut in December. This view emerged after weaker-than-expected July employment data. At that time, JPMorgan even argued that there was a strong case for the Fed to deliver an intermeeting rate cut before September 18, which would have been the first such move since March 2020.

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Initially, the market agreed with this view, pricing in nearly 125 basis points of easing by year-end. However, stronger retail sales figures and a decrease in jobless claims tempered expectations. Now, swaps indicate about 110 basis points of easing by the end of the year, still leaving room for at least one 50-basis-point cut.

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Recently, Citi and JPMorgan have adjusted their perspectives without changing their forecasts. Citi noted that if the U.S. unemployment rate falls from 4.3% to 4.2% in August, the Fed might opt for a smaller 25-basis-point cut unless payroll growth is also weak. Similarly, JPMorgan stated that the likelihood of a 50-basis-point cut depends largely on the strength of the August jobs report.

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If the employment data doesn’t provide a clear signal for either a quarter-point or half-point cut, the market could turn to the August consumer inflation data, scheduled for release on September 11, for further clues. Should that data also fail to provide clarity, the Fed may break its silence ahead of its policy meeting to offer some guidance, according to Raskin.

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“They don’t like to surprise the market at policy meetings,” he said, emphasizing the Fed's preference for managing market expectations ahead of time.

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