July Data Throw Size of First Fed Rate Cut Into Doubt

Investors have gone from debating whether the Federal Reserve will lower interest rates in July to all but assuming that is a foregone conclusion.

The question they are grappling with now: Will the Fed’s first rate cut since the financial crisis take the federal-funds rate down by 0.25 percentage point or 0.5?

Federal-funds futures show traders have been ramping up odds for the latter in the past couple of months. The market priced in around a zero percent chance of a 0.5 percentage-point cut for much of May, only to bump up those odds as high as 43% in late June after the Fed’s policy meeting, according to

CME Group
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Odds for a 0.5-percentage-point cut jumped to a fresh 2019 high of 71% Thursday after John Williams, president of the Federal Reserve Bank of New York, said central banks should “take swift action when faced with adverse economic conditions.”

UBS Group
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, one of the few investment banks currently predicting a 0.5 percentage-point cut in July, points to Fed Chairman Jerome Powell’s congressional testimony from earlier in the month as proof that the central bank hopes to stave off an economic slowdown with a big cut.

But many others say it is difficult to imagine the Fed lowering interest rates by that much with stocks sitting near records and recent data pointing to a resilient U.S. economy. In just the past few weeks, data on the labor market, inflation and retail sales have all surprised to the upside. Even the manufacturing sector—an area of the economy that struggled earlier in the year—has seemingly started to perk up: Fed data showed output at U.S. factories rose in June, extending its May rebound.

“The case for interest-rate cuts looks increasingly weak as the economy is turning out to be stronger than expected both from the consumer side and on the part of manufacturers,” said Chris Rupkey, managing director and chief financial economist at MUFG.

Fading confidence in a 0.5 percentage-point cut has trickled into the bond market, where yields—which tend to rise as investors grow more optimistic about the economic outlook—have bounced off the lows they hit at the start of the month. The yield on the benchmark 10-year U.S. Treasury note settled Thursday at 2.040%, compared with the roughly 2½-year low of 1.952% it hit on July 3.

In other words: Don’t count on the Fed deploying a big rate cut just yet.

“I believe that would actually be cause for alarm,” said Kristina Hooper, chief global market strategist at Invesco, in a note. “In my view, such a move is more appropriate for an economy that is not as healthy as the current U.S. economy.”

As the Fed contemplates rate adjustments, WSJ’s Nick Timiraos takes a look at four factors the Fed considers, and one thing it tries to ignore. Graphic Illustration: Adele Morgan

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What would be a good reason for the Federal Reserve to cut rates dramatically? Join the conversation below.

Write to Akane Otani at akane.otani@wsj.com

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