Traders See Half-Point Fed Rate Cut Likelier Than Quarter-Point

(Bloomberg) — Bond traders once again see Federal Reserve policymakers as more likely to cut interest rates by a half point than a quarter point at their meeting this week.

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Swaps tied to the Fed’s decision on Wednesday priced in more than a 50% chance of a half-point cut, after virtually discounting the possibility entirely last week. That brought the yield on two-year US bonds back toward the lowest level in two years and dragged a gauge of the dollar to the weakest since January.

The reversal in pricing over the past few sessions has raised the stakes for the Sept. 18 decision. Investors are conflicted over how much policy support the economy needs, and what the Fed’s decision to kick off its easing cycle with a large cut would signal.

“It is a close call,” wrote Philip Marey, a senior US strategist at Rabobank, who expects the Fed to deliver a standard quarter-point decrease. “The lack of guidance from Powell could indicate that the FOMC has not reached a consensus yet. What’s more, Tuesday’s retail sales could still alter the calculus.”

It all comes against the backdrop of an increasingly fraught political situation in the US. The FBI is investigating an apparent assassination attempt against former President Donald Trump, just two months the Republican presidential candidate was shot at a rally in Pennsylvania. For now, the market looked past the development, with US stock futures pointing to modest gains at the open.

The yield on two-year Treasuries traded four basis points lower at 3.54% on Monday, extending a rally that’s seen the yield collapse from a high of over 5% in late April.

With Fed members in a blackout period before the Sept. 17-18 policy meeting, traders have few data points to rely on, including August retail sales on Tuesday.

The repricing in expectations meanwhile has taken a toll on the dollar, which has weakened against most major currencies over the past month. The yen is among the biggest gainers, advancing past the closely watched 140 per dollar level on Monday.

“We see a new and imminent Fed easing cycle as a major headwind for the dollar,” said Rodrigo Catril, strategist at National Australia Bank Ltd. “The dollar will embark on a cyclical decline as the Fed eases and takes the fund rate toward neutral, if not below, next year.”

While a technical indicator is signaling support for the dollar as momentum turns bearish, the market is overwhelmingly in the camp of a weaker US currency. The euro, yen, Canadian and Australian dollars are all forecast to strengthen against the greenback by this time next year, Bloomberg surveys of analysts show.

–With assistance from Michael G. Wilson.

(Updates to show latest market-implied odds favor half-point cut.)