Momentum grows for 50 bps Fed cut

CHICAGO (Reuters) - U.S. short-term interest rate futures showed a growing appetite for a large Federal Reserve rate cut on Tuesday on ideas the Fed needs to take a bold step to shore up flailing financial markets.

"The U.S. central bank is facing a state of crisis in the financial markets from a perspective of solvency, liquidity and confidence," said Ashraf Laidi, chief FX strategist at CMC Markets US in New York.

Futures fully price a 25 basis-point rate cut following Tuesday's Federal Open Market Committee meeting, and showed about a one-in-three chance that the Fed will slash rates by 50 basis points, to 1.5 percent.

Prospects for an aggressive rate cut were on the rise as stock index futures tumbled ahead of the day's opening on Wall Street.

Several investment banks, including Merrill Lynch and UBS, are now calling for the Fed to slash the fed funds rate by as much as 50 basis points,

"We expect a 50 basis-point rate cut in the fed funds rate to 1.50 percent, along with a similar 50-bps easing in the discount rate to 1.75 percent," Laidi said.

A small decline in the year-on-year consumer inflation rate and another slide in crude oil and overall commodity prices on Tuesday could help give the Fed cover to lower rates.

For August, the closely-watched consumer price index fell by 0.1 percent in August while the core CPI, stripped of food and energy prices, rose by 0.2 percent -- both as expected.

That knocked the year-over-year CPI to 5.4 percent from 5.6 percent in the year through July, consistent with ideas that, while still high, inflation has peaked.

Core prices were up 2.5 percent on the year through August, similar to the rate in the year ended in July.

"Broader declines in CPI should allow the Fed to leave rates unchanged in the months ahead (or cut rates amid current market weakness)," strategists at IDEAglobal said in a research note. "Inflationary pressures should push lower in the coming months."