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Federal Reserve

Traders slash expectations for a rate cut after the Fed says it's staying put

Key Points
  • Traders briefly cut the chances for a rate cut this year below 50% on Thursday.
  • The move comes a day after Fed Chairman Jerome Powell said the central bank believes low inflation is "transient."
  • Stocks fall sharply Wednesday after Powell's remarks.

Traders are coming to grips with the reality that the Federal Reserve may not be cutting interest rates this year after all.

The likelihood that the central bank will reduce the overnight funds rate briefly fell below 50% for the first time in weeks, according to CME's tracker of futures trading for the Fed's benchmark.

As recently as Wednesday afternoon, traders had been assigning a 67% chance that the Fed would approve a quarter-point cut, most likely at the December meeting. Around noon Thursday, the chance for a cut had been reduced to 52%.

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Powell: We expect inflation will move back up

However, remarks from Fed Chairman Jerome Powell after the Federal Open Market Committee meeting pointed to a central bank not worried about lackluster inflation readings and instead committed to holding rates right where they are now, in a target range between 2.25% and 2.5%.

Stocks dropped sharply during Powell's news conference and added to those losses Thursday as the Dow Jones industrials lost nearly 250 points heading into midday.

Market chatter increasingly had been pointing to the Fed approving an "insurance" rate cut to stave off a potential downturn in the economy, and President Donald Trump earlier in the week called for a full percentage point reduction.

"In our view, the Fed will only take out such an insurance policy if they begin to seriously doubt their inflation forecast," Ethan Harris, global economist at Bank of America Merrill Lynch, said in a note to clients. "The Fed has limited ammunition and wants to use it when it will be effective."

Powell called the current weak inflation readings — about 1.6% core, according to the Fed's preferred measure — transient and likely to reverse in the months ahead. He cited the Dallas Fed's trim mean inflation measure, which was 2% for March.

Another metric, the New York Fed's underlying inflation gauge, rose 2.9% in March.

Powell's insistence that inflation will drift toward the Fed's 2% goal still has some doubters, despite what the futures trading showed Thursday.

"We don't buy the automatic path to higher inflation story," said Jeremy Hale, head of global macro strategy and asset allocation at Citigroup. Despite signs of a growing economy, Hale said, "the growth numbers are still unlikely to be strong enough to make the Fed confident of hitting inflation targets finally, let alone exceeding them."

In the end, Hale said, he thinks the Fed will cave to market pressure.

"The Fed rarely resists the signal for long," he said.