Another surge! The probability of the Federal Reserve cutting interest rates by 50 basis points this week has exceeded 50%

Bond traders once again believe that Federal Reserve policymakers are more likely to cut interest rates by 50 basis points at this week's meeting rather than 25 basis points.

Interest rate swap contracts linked to the Fed's rate decision show that the probability of a 50 basis point rate cut by the Fed this week is over 50%, compared to last week when traders almost completely ruled out this possibility. This has pushed the two-year U.S. Treasury yield back to its lowest level in two years and dragged the dollar index to its lowest level since January.

The recent market reversal in the past few trading days has increased the risks surrounding the Fed's September policy meeting. There is a divergence of views among investors on how much policy support the economy needs and what signal the Fed's decision to start a loosening cycle with a significant rate cut will send.

With Fed members in a blackout period before the policy meeting, traders have limited data to rely on, including Tuesday's August retail sales.

"This will be a nail-biting decision," wrote Philip Marey, Senior U.S. Strategist at Rabobank, who expects the Fed to implement a standard 25 basis point rate cut. "Powell's lack of guidance may indicate the FOMC has not yet reached a consensus. More importantly, Tuesday's retail sales could still change market expectations."

All of this is happening against the backdrop of an increasingly tense U.S. political situation. The FBI is investigating an apparent assassination attempt against former President Trump, who just two months ago, the Republican presidential candidate was shot at a rally in Pennsylvania. Currently, the market is ignoring the developments, with U.S. stocks opening slightly higher.

On Monday, the two-year U.S. Treasury yield fell 4 basis points to 3.54%, continuing its trend of sharp declines from highs above 5% in late April.

However, BlackRock strategists have shifted their stance on short-term U.S. Treasuries from neutral to underweight, stating that the market's bet on the extent of the Fed's rate cut is unlikely to succeed. With U.S. Treasury yields already relatively high, BlackRock strategists favor mid-term U.S. Treasuries in the 5 to 10-year range.

The company's Chief Investment Strategist Wei Li stated that speculation about the Fed waiting too long to ease policy and now being forced to accelerate rate cuts to boost the economy is incorrect. In an interview, she said, she expects the Fed to cut rates by 25 basis points on Wednesday.

Li said, "We think the market has priced in the depth of the rate cut cycle a bit too high. The rate cut cycle is starting, but the magnitude may not be as large as the market has priced in."

While Li acknowledges that recession risks may have increased, she stated that her base case is still for the U.S. economy to slow down rather than contract. She mentioned that policymakers remain cautious about "persistent" inflation in certain areas of the economy.

She explained, "What we are seeing is the U.S. creating an average of 164,000 jobs per month over the past six months, which is still a fairly robust pace." The repricing of market expectations for a Fed rate cut has also affected the US dollar, which has weakened against most major currencies over the past month. The Japanese yen is one of the currencies with the largest gains, breaking through the key level of 140 on Monday.

Rodrigo Catril, a strategist at National Australia Bank Limited, said, "We believe that the upcoming new easing cycle by the Fed is the main obstacle for the US dollar. As the Fed eases policy and pushes interest rates towards a neutral or even lower level next year, the dollar will begin to decline cyclically."

While a technical indicator suggests support for the US dollar, the market overwhelmingly stands in the camp of a weak dollar. According to a Bloomberg survey of analysts, it is expected that by this time next year, the euro, yen, Canadian dollar, and Australian dollar will all strengthen against the US dollar.