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Market Odds of a Fed Rate Cut Are Rising

Amid worries about the U.S.-China trade spat and the economy, traders are more convinced a quarter-point Federal Reserve rate cut is coming this year.

The rate on the January fed funds futures contract implies that the central bank’s benchmark will fall to 2.075% 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%.

This is happening as China threatens retaliatory tariffs on some American imports, an escalation in the trade war with U.S. President Donald Trump. The clash is fueling concern about economic growth, prompting a key part of the U.S. yield curve to invert again — a sign to many that the risk of a recession has increased.

While “China/U.S. 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 presented risks to the Fed’s outlook. He added that the risks had moderated somewhat.

Yields on 3-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 2.18%, approaching the 2019 low of 2.16% set on March 27.