US RATE FUTURES-Bets tilt further toward 50 bps Fed cut

By Ros Krasny

WASHINGTON, Oct 21 (Reuters) - U.S. short-term interest rate futures on Tuesday tilted further toward an aggressive rate cut at next week's Fed policy meeting, picking up on prospects for an protracted slowdown in the U.S. economy.

For the first time, futures suggest more than a 60-percent chance for the Fed to lower rates by one-half percentage point at the Oct. 28-29 meeting, backing up a similar-sized emergency cut on Oct. 8.

Buying in fed funds futures was also driven by a rate cut by the Bank of Canada on Tuesday, along with hints that further easing could be in the pipeline for the United States' northern neighbor as world growth softens.

"The global economy appears to be heading into a mild recession, led by a U.S. economy already in recession," the Bank of Canada's statement said.

By day's end, rate futures showed a 66-percent implied chance for a 1 percent fed funds at after the Federal Open Market Committee meeting, up from 48 percent on Monday and just 8 percent a week ago. A 25 basis-point rate cut, to 1.25 percent, is fully priced.

"The market continues to slowly shift to pricing in a 50 basis-point ease by the Fed next week, which is our call," said Rudy Narvas, analyst at 4CAST Ltd in New York.

The upward drift in rate cut ideas is occurring despite more signs that global money markets are starting to thaw out after central banks took a series of actions to bolster liquidity and shore up the banking system.

LIBOR rates are falling sharply from elevated levels that reflected extreme risk aversion in the interbank lending market.

Three-month dollar-denominated LIBOR was set on Tuesday at 3.83 percent, down from Monday's 4.05 percent. As recently as Oct. 10, the rate was fixed at 4.81 percent, but the rate is still about 100 basis points above its level before the Lehman Brothers bankruptcy in September.

With money markets apparently on the mend, dealers said futures were responding to comments on Monday from Fed Chairman Ben Bernanke that a "protracted slowdown" is possible.

Bernanke also endorsed a potential second fiscal stimulus package to support the United States economy.

Fresh weakness in U.S. equities markets heightened prospects for a rate cut, although the Dow Jones industrial average .DJI managed to hold the 9,000-point level.

"Futures are also being skewed higher as investors park cash in this short-term instrument (but) there are increased forecasts for deep cuts in interest rates," said strategists at Action Economics.

Some Fed watchers expect the funds rate to be cut as low as 0.5 percent, according to a recent Reuters survey. By contrast, futures do not price a rate under 1 percent, and look for the Fed to start raising rates again by mid-2009. (Editing by James Dalgleish)