The more markets price in a jumbo rate cut, the more likely the Fed is to deliver, analyst says

• Traders see heightened odds of a big initial rate cut from the Federal Reserve this week.
• As markets price in rising odds of a 50 basis point cut, the Fed may be more likely to deliver, BMO's Ian Lyngen says.
• He says markets pricing an 80% chance of a big rate cut could sway the Fed. Odds currently stand at 63%.

Investors have been pricing in rising odds of a 50 basis point interest rate cut from the Federal Reserve.

And as the market increasingly positions for a jumbo cut, the Fed may be more likely to deliver, according to BMO's head of US rates strategy Ian Lyngen.

"While we're still in the 25 bp camp, we'll concede that the more aggressively the market prices in 50 bp, the more compelled the Fed will be to follow-through with such a move," Lyngen said in a Monday note.

Markets on Tuesday afternoon were pricing in a 63% chance of a 50 basis point cut, versus 37% odds of a 25 basis point move, according to CME's FedWatch tool.

Investors think the likelihood of the bigger move has almost doubled since last week, when the market expected just 34% odds.

Lyngen says the probability will need to reach 80% for the Fed to be convinced to initiate a big initial move down in its benchmark rate.

"I suspect that if we go into the event priced with a higher than 80% probability of 50 [basis points], that there's a really good chance that they move 50 simply to front load the process," Lyngen said in a Tuesday interview with Bloomberg Surveillance.

Some analysts have said the Fed should cut 50 basis points to quickly ease policy amid a cooling labor market. Others have said such a deep initial cut would likely spook markets, and could lead to a sell-off on fears of a recession.

Lyngen reiterated the tough nature of Fed communications but said the central bank will likely aim for a more neutral perspective whether they make a small or large cut.

"This becomes tricky for the Fed from a communications perspective," Lyngen said.

He noted, too, that there's a chance of dissent within the Fed. If that's the case, it could help further quell markets' worries about the state of the economy in the case of a jumbo rate cut.

"There's nothing to suggest that everyone needs to vote in for 25 or 50. So I think that could be another way to communicate to the market that it was a knife's edge decision and it's uncertain going forward," Lyngen said.

The Fed will announce its decision at 2 p.m. ET on Wednesday.