European stocks are higher while the US dollar is pinned lower, a day before the Federal Reserve is expected to begin an easing cycle that could have policymakers delivering an outsized rate cut.

Investors remain solely focused on Wednesday’s Fed decision as chances have crept up in the past week in favour of a 50-basis-point rate cut.

Futures markets are fully pricing in a quarter-point cut and now imply a 65 per cent chance the Fed could ease rates by half a percentage point on Wednesday, up from around a 15 per cent chance last week, after a slew of media reports revived the prospect of more aggressive easing.

The repricing by markets in favour of a deeper cut has given a boost to risky assets and sent the dollar and bond yields lower.

“Everyone’s pricing in the soft landing and it feels like the Fed have been quite transparent that we’re in a rate cutting environment,” said Eddie Kennedy, head of bespoke discretionary fund management at Marlborough Investment Management. 

“Generally stocks have done well post those sort of environments.” 

The pan-European STOXX 600 was up 0.6 per cent to a two-week high on Tuesday. Germany’s DAX, Britain’s FTSE 100 and France’s CAC 40 were also up about 0.6 per cent.

MSCI’s broadest index of Asia-Pacific shares rose 0.5 per cent, while S&P 500 futures and Nasdaq futures were higher.

MSCI’s gauge of global equities was up 0.1 per cent.

Neil Shearing, group chief economist at Capital Economics, thinks the case for a 50 bps rate cut this week hinges in part on the idea that rates are well above most estimates of neutral.

“If officials judge that keeping policy in restrictive territory for too long creates unnecessary risk for the economy then there is no sense in dragging their feet,” Shearing said.

“The problem is this is a high bar for a large rate cut, particularly at the start of the easing cycle. If nothing else, it creates the impression that central bankers have made a mistake and fallen behind the curve.”

Markets have priced roughly 120 bps worth of Fed easing by December.

The two-year US Treasury yield, which typically reflects near-term rate expectations, was last at 3.5673 per cent, having fallen to a two-year low of 3.528 per cent in the previous session.

The benchmark 10-year yield was little changed at 3.6176 per cent.

The Bank of England (BoE) and the Bank of Japan (BOJ) also meet this week to discuss monetary policy, where both central banks are seen keeping rates on hold.

Expectations of less aggressive easing by the BoE in contrast to the Fed have in turn kept sterling supported. It was last flat at $1.3209, but strayed not too far from August’s peak of $1.3269, its strongest level since March 2022.

The BOJ meanwhile has raised interest rates twice this year but is also expected to hold off from action this week.

Still, the recent fall in US Treasury yields and expectations that the BOJ will have to tighten policy further has supported the yen against the dollar.

The Japanese currency was last at 140.66 per dollar, close to its strongest level in a year reached on Monday.

The stronger yen has stoked concerns about Japanese exporters’ earnings and pulled down Tokyo’s Nikkei by 1 per cent on Tuesday as the market returned from a national holiday on Monday.

Elsewhere in Asia, China’s stuttering economic recovery continued to weigh on sentiment, after data over the weekend showed the country’s industrial output growth slowed to a five-month low in August, while retail sales and new home prices weakened further.

Still, concerns over faltering Chinese demand for oil were countered by the ongoing impact of Hurricane Francine on output in the US Gulf of Mexico, keeping oil prices steady on Tuesday.

Brent crude futures were little changed at $72.72 a barrel, while US crude futures were up 0.2 per cent at $70.22 per barrel.

Spot gold was down 0.3 per cent at $2574.67 per ounce, having touched a new record high on Monday.

This post was originally published on Michael West.