Chances of a rate cut by the Federal Reserve later this month rose after a disappointing services reading fueled fears that the economic slowdown would tip the U.S. into a recession.
Traders are now pricing in a 92.5% chance of a quarter-point rate cut at the Fed's October meeting and a 50% chance of another reduction in December, according to the CME FedWatch tool. The tool is based on futures pricing from live markets and reflects the views of traders placing real bets on the CME exchange.
The services sector grew at a considerably slower pace than expected in September with the ISM nonmanufacturing index posting its the weakest reading since August 2016. The stock market sold off sharply on the data.
"My bottom line is that the weakness in manufacturing has now infected the services side of the U.S. economy which makes up about 80% of it," said Peter Boockvar, chief investment officer at Bleakley Advisory Group.
The weak services sector data came as U.S. business took a big hit from the tit-for-tat tariffs in the U.S.-China trade war. The manufacturing sector is also flashing red as ISM posted its weakest reading in more than 10 years earlier this week.
"This downturn is starting to spread and that means the tea leaf readers at the Fed are going to be teeing up a third rate cut this year when they next meet again at the end of this month," Chris Rupkey, chief financial economist at MUFG, said in a note. "Policymakers are going to need a bigger gun to stop this avalanche of bad news from dragging down business and consumer confidence even further. Rate cuts are coming. Lots of them. Bet on it."
The Fed cut its benchmark overnight lending rate to a target range of 1.75% to 2% in September, the second time this year. The central bank cited uncertainties around trade and muted inflation as headwinds to the U.S. economy.