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MONEY MARKETS-Traders bet on more than 'insurance' U.S. rate-cut from Fed

Richard Leong

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NEW YORK, May 29 (Reuters) - Interest rates traders are betting the Federal Reserve may lower key U.S. borrowing costs multiple times in the coming months to counter the possible economic drag from the worsening trade fight between China and the United States.

At the beginning of the year, traders started carving out bullish positions in U.S. rates futures on views that the U.S. central bank may consider a stand-alone rate decrease late this year as an insurance move to prolong the current economic expansion.

That view on an "insurance" rate-cut was buoyed by a dramatic policy shift by the Fed in March, when policymakers signaled they do not expect to raise rates in 2019.

Three months earlier, Fed officials had forecast two rate increases this year following four hikes in 2018.

The surprise deterioration in trade talks between Beijing and Washington this month touched off a round of bets that the Fed may be forced to reduce rates more than once, starting as early as September to stabilize the economy and financial markets, analysts said.

"Both the stock and bond market have recently been trading in a way that suggests that they are begging the Fed to cut rates," Jefferies' senior money market economist Tom Simons wrote in a research note on Wednesday.

On Wednesday, the S&P 500 fell 0.7%, off 5.5% from its April 30 closing high, while benchmark 10-year Treasury yields hit 2.21%, the lowest since September 2017.

"What once was an 'insurance cut' of 25 basis points being priced into the next 12 months has morphed into an expectation that the Fed is going to cut multiple times," Simons added.

Late on Wednesday, federal funds futures implied traders saw about a 54% chance of a quarter-point rate cut, to 2.00%-2.25%, at the central bank's Sept. 17-18 policy meeting, CME Group's FedWatch program showed.

By December, fed funds contracts suggested traders priced an 83% probability of at least one rate cut, up from 64% a month earlier.

By year-end, rates futures implied traders saw the likelihood of two or more rate cuts at nearly 43%, compared with 23% a month earlier, according to the FedWatch program.

The fed funds complex, which measures traders' expectations on what banks charge each other to borrow reserves overnight, suggested bets the Fed might lower short-term rates by one full percentage point by year-end.

(Reporting by Richard Leong Editing by Chizu Nomiyama and Dan Grebler)