Federal Reserve fuels speculation for sharp interest rate cut

The U.S. central bank is fueling speculation that a major interest rate cut is imminent. The President of the Federal Reserve of New York, John Williams, said in a recent speech that it is better to take 'preventive measures' than to wait for things to go wrong. In doing so, he points in the direction of an interest rate cut at the central bank's next meeting at the end of this month. 

According to Williams, the Federal Reserve should cut interest rates immediately if the first signs of economic weakness become visible. Instead of keeping the proverbial powder dry, the central bank should act proactively in order to send a strong signal to the market. He had this to say about it.

"When the zero percent limit is nowhere to be seen, you can afford to take slow steps and adopt a wait-and-see attitude. But that is not possible if interest rates are close to zero. In that case, you want to do the opposite and vaccinate against further ailments. If you only have a limited amount of stimulus at your disposal, it pays to quickly cut interest rates in the event of economic stress."

'Neutral interest rate of 0.5%'

The statements of John Williams ensure speculation on the financial markets. Will the Federal Reserve cut interest rates by more than 25 basis points later this month? Or will there be multiple rate cuts later this year? Before Williams' speech, the probability of a 50 basis point rate cut was estimated at around 40%, but now that probability has risen to 66%. So, investors are taking into account that the Federal Reserve will cut interest rates much faster.

The central banker also said in his speech that the "neutral" interest rate for the Federal Reserve should not be at 2.5% at the moment, but only at 0.5%. The neutral interest rate is the interest rate that, according to the central bank, has neither a stimulative nor a restraining effect on the economy. These statements are also interpreted by the market as an indication of a reduction in interest rates. The question is therefore no longer whether the US central bank will cut interest rates this month, but at what pace.

Investors are already pricing in a 50 basis point rate cut (Source: Financial Times, Bloomberg)