Fed-Cut Bets Firmed on Iran Tension, But Just One Easing Is Seen

(Bloomberg) — Traders have firmed in their conviction that that the Federal Reserve will trim interest rates further as concern swirls around the deteriorating global geopolitical situation. But they’re far from pricing in the more dire economic scenarios seen several months ago.

Fed funds futures are now fully pricing in a quarter-point cut by the end of 2020. The probability of such a move was closer to 70% on Thursday. It then surged Friday in the wake of the U.S. airstrike that killed Iranian General Qassem Soleimani and upended the political situation in the Middle East. The tension also drove investors into longer-maturity Treasuries, flattening the U.S. yield curve.

Yet the level of concern the market moves are signaling remains modest relative to the second half of 2019. In early September, trade-war angst helped push expectations for where the Fed target rate might end 2020 below 0.9%. The expectation now is for it to be around 1.30%, a quarter-point below the current fed funds effective rate. The central bank lowered borrowing costs three straight times in 2019 before pausing last month.

“It’s a little premature” to price in further cuts based on geopolitics, said Subadra Rajappa, head of U.S. rates strategy at Societe Generale (PA:). “The Fed pricing aligns more with economic fundamentals — that could of course quickly change if we saw a further sell-off in risky assets.”

This week’s economic data are expected to confirm that the services sector, which dominates U.S. economic activity, is expanding at a healthy pace.

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