By Samuel Indyk and Ray Wee
LONDON (Reuters) – European shares rose on Tuesday but the U.S. dollar fell as the Federal Reserve was expected to begin an easing cycle and policymakers could potentially cut interest rates sharply.
Investors remain focused solely on the Fed's decision on Wednesday, as the likelihood of a 50 basis point rate cut has increased over the past week.
Futures markets have fully priced in a quarter-point cut, and the chances of the Fed cutting rates by half a percentage point on Wednesday have risen to nearly 70% from about 15% last week after a series of media reports rekindled the prospect of more aggressive easing.
Risk assets rose and the dollar and bond yields fell as markets repriced further rate cuts in their favor.
“We're back to the Fed put,” said Eddie Kennedy, head of bespoke discretionary fund management at Marlborough Investment Management.
“Everyone is pricing in a soft landing and the Fed seems to have made it pretty clear that we're in a rate-cutting environment. Generally, stocks do well after that kind of environment,” Kennedy added.
The European Composite Index rose 0.5% to its highest in two weeks, while the 100 and 40 indexes rose between 0.3% and 0.7%.
MSCI's broadest index of Asia-Pacific shares rose 0.6%, while Nasdaq futures were both slightly higher.
MSCI's index of global stocks rose 0.1%.
Neil Shearing, group chief economist at Capital Economics, believes the rationale for this week's 50 basis points cut rests in part on the notion that interest rates are running much higher than most neutral rate expectations.
“If officials judge that keeping monetary policy in restrictive territory for too long poses unnecessary risks to the economy, there is no point in stalling,” Shearing said.
“The problem is that the bar for any significant rate cuts is high, especially early in an easing cycle. At the very least, it creates the impression that central banks have made a mistake and are becoming outdated.”
This year, the market is pricing in roughly 120 basis points of easing through December.
The yield on the two-year Treasury note, which typically reflects expectations of short-term interest rates, fell to a two-year low of 3.528% in the previous trading day and was last at 3.5527%.
The benchmark 10-year Treasury yield was little changed at 3.6157%. [US/]
Price determination
The Bank of England (BoE) and the Bank of Japan (BOJ) will also meet this week to discuss monetary policy, but both central banks are expected to keep interest rates on hold.
Sterling has also been supported by expectations that the Bank of England will ease monetary policy less aggressively than the Fed. The pound was last trading flat at $1.3216, not far from its highest since March 2022 at $1.3269 in August.
Meanwhile, the Bank of Japan has raised interest rates twice this year but is expected to refrain from action this week.
Still, the recent decline in U.S. Treasury yields and expectations that the Bank of Japan will be forced to tighten monetary policy further are supporting the yen against the dollar.
The yen was trading at 140.61 to the dollar, approaching a one-year high hit on Monday.
Tokyo stocks fell 1 percent on Tuesday as markets returned from Monday's holiday as a strong yen raised concerns about the profits of Japanese exporters.
Elsewhere in Asia, a faltering economic recovery in China continues to weigh on sentiment, with data released over the weekend showing the country's industrial production growth slowed to its slowest in five months in August, while retail sales and new home prices also fell further.
Still, oil prices held steady on Tuesday as the continuing impact of Hurricane Francine on U.S. Gulf of Mexico production offset concerns about weaker Chinese demand for crude.
Futures were little changed at $72.58 a barrel, while futures were flat at $70.04 a barrel. [O/R]
It was little changed at $2,582.52 an ounce. [GOL/]
