The yield on the 2-year US Treasury fell and stocks rose yesterday after the Federal Reserve indicated it would "act to sustain the expansion" if trade tensions undermined growth. While rates were kept on hold, the Fed did open the door to easing.

Following the January meeting of the Federal Open Market Committee (FOMC), the Fed's decision-making body, the word "patient" was added to its statement, signaling anintention to leave rates unchanged in the near term. This time the FOMC dropped "patient," saying that uncertainties have increased. Further, it "will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion." This language puts the Fed back into data-dependent mode and makes it easier for it to lower rates.

The dot plot appears to indicate a close balance between FOMC participants who expect to cut rates and those who anticipate leaving them unchanged. Importantly, in his post-meeting press conference, Fed Chair Jerome Powell noted that even those expecting to leave rates unchanged agreed that the case for a rate cut had strengthened. So it appears it would not be too difficult for the FOMC to reach consensus on a rate reduction.

Markets are now pricing in a very high probability of one at the next Fed meeting on 31 July, with a good chance that it will be 50 basis points rather than 25. Powell lent support to the idea that starting with a larger cut might be appropriate under current circumstances.

Historically, when markets have priced in rate changes going into an FOMC meeting, the Fed has moved in line with such expectations. Given current market pricing, the Fed is likely to lower rates in July unless there is a big move in markets before the meeting. We have changed our base case to call for a 50 basis point cut.

But this is a close call and we still see a significant chance that the Fed will remain on hold. We expect President Donald Trump and President Xi Jinping to agree to a ceasefire on the US-China trade dispute at the G-20 meeting later this month, which would help to reduce uncertainty. Further, we expect above-trend GDP growth in 2Q19, and this data will be announced just ahead of the next FOMC meeting. These developments could affect the likelihood of a July rate cut.

Fed policy will also depend on the inflation and labor market data. Core personal consumption expenditures (PCE) inflation has slowed in recent months, moving below the Fed's 2% target, and market-based measures of inflation expectations have also fallen. This is a main motivation for the Fed to consider lowering rates. Further weakness over the next six weeks would add encouragement.

Job growth has been vibrant on average this year and the unemployment rate is low, but data for May surprised to the downside. A rebound in June might persuade the Fed to wait for more data before deciding on any policy moves, while payroll growth below 100,000 or rising unemployment would strengthen the case for a July cut.

So, we are tactically overweight equities and carry – through an overweight in a basket of high-yielding emerging market currencies against a basket of lower-yielding G10 currencies – which should benefit from a more dovish Fed. We position for the risk that the Fed will disappoint the market and cut by less than expected by underweighting US two-year Treasuries relative to cash. We also position to benefit in areas that diverge from the trend toward easier monetary policy, such as our overweight Norwegian krone.