Market pricing in a 2019 Fed cut and bets emerge for even more

[NEW YORK] Amid worries about the US-China trade spat and the economy, traders are more convinced a quarter-point Federal Reserve rate cut is coming this year. Some appear to be betting on the possibility of more.

The rate on the January fed funds futures contract implies that the central bank's benchmark will fall to 2.075 per cent by the end of 2019. This is more than 25 basis points below where the effective fed funds rate stood Friday, showing traders are fully pricing in a quarter-point reduction. The implied rate on the contract ended last week at 2.15 per cent.

In the eurodollar options market, a bet cropped up on Monday suggesting that as many as three quarter-point cuts could be in the works this year. A call structure position has emerged that targets 50 to 75 basis points of reductions by mid-October, according to information from a Chicago trader, who asked not to be identified because they're not authorised to speak publicly. The premium on the bet appeared to be around US$2.5 million.

This is happening as China threatens retaliatory tariffs on some American imports - an escalation in the trade war with US President Donald Trump.

The clash is fueling concern about economic growth, prompting a key part of the US yield curve to invert again - a sign to many that the risk of a recession has increased.

While "China/US trade ripple effects certainly affect the Fed's outlook, I think this is more of a macro move," said Todd Colvin, senior vice president at futures and options broker Ambrosino Brothers in Chicago.

"It's not about whether or not the Fed sees policy shifts, that is, as much as it's looking at global growth woes, or increased market volatility."

At his press conference following this month's Federal Open Market Committee meeting on May 1, Fed Chairman Jerome Powell included uncertainty around unresolved trade negotiations as one of many cross currents that posed risks to the Fed's outlook. He added that the risks had moderated somewhat.

Yields on three-month Treasuries are again higher than those on 10-year notes, an atypical relationship that also briefly occurred in March.

The move back toward this rate inversion picked up steam about a week ago when Trump said he'd increase tariffs on Chinese goods.

On Monday, the yield on 2-year Treasuries touched 2.17 per cent, approaching the 2019 low of 2.16 per cent set on March 27.

BLOOMBERG