Bond Traders Favor Half-Point Cut In Fed’s ‘Coin Flip’ Decision

Bond traders are favoring bets the Federal Reserve will kick off its interest-rate cutting cycle with a half-point move this week as debate rages on over whether officials can pull off a rare soft landing.

The market-implied odds that policymakers announce a 50-basis-point rate reduction were around 55% on Tuesday after retail sales data unexpectedly rose in August, suggesting resilience among US consumers. That keeps uncertainty in financial markets high going into the Fed’s September policy decision on Wednesday.

“The decision is essentially a coin flip,” Blerina Uruci, chief US economist at T. Rowe Price, told Bloomberg Television. “It is possible we get a 50-basis-point cut tomorrow,” and the Fed’s summary of economic projections “will probably show the dot plot has 100 basis points worth of cuts for the year as a whole.”

Debate over the size of the Fed’s first rate cut in four years has been dominating financial markets for months, fueled by economic reports and speeches by Fed officials. Traders have fully priced in a quarter-point move, and have in recent days piled into bets on a larger, 50-basis-point move as speculation mounted over the Fed’s decision.

Treasuries have been rallying in anticipation of rate cuts, with a Bloomberg gauge of returns on course for a fifth-straight month of gains. That would mark the index’s best monthly winning streak since 2010. The advance has pressured yields lower, with nearly the entire curve — aside from the 20-year bond — trading below 4% on Tuesday.

Investor demand was soft for a $13 billion 20-year bond auction at 1 p.m. New York time. The auction result was 4.039%, two basis points higher than its yield at the bidding deadline, a sign of that interest fell short of expectations. Long-maturity yields eked out new session highs afterward.

Earlier Tuesday, US August retail sales unexpectedly rose, supported by online purchases that masked more mixed results at other merchants, and August industrial production exceeded expectations. 

The data weighed on Treasuries, and in early afternoon trade in New York, the two-year yield was higher by four basis points at 3.60%, the 10-year by three basis points at 3.65%. The dollar gained against most of its Group-of-10 currency peers. 

“Retail sales for August beat expectations in aggregate. That’s in line with robust leading data, but is incommensurate with the 50-basis-point interest-rate cut the market still sees as more likely than not that the Federal Reserve will deliver this week.” — Simon White, Markets Live macro strategist

The swaps market, though, is still pricing in some 76 basis points worth of easing by the November meeting, implying one half-point move over the next two decisions.

Over the next 12 months, traders have priced in 243 basis points of easing, a pace of cuts that if realized would bring Fed policy down toward 3%.

“There’s a recipe for a back up in yields,” as the market has priced in a ton of easing, Ashok Bhatia, deputy co-chief investment officer at Neuberger Berman Group, told Bloomberg Television. “It will be hard for the Fed to deliver all of that based on what we know now.”