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Odds of October rate cut jump after weaker US services data

Traders have become increasingly convinced that the Federal Reserve will lower its benchmark interest rate again in October after a week of key economic indicators pointed to weaker U.S. momentum.

The probability of an October rate cut jumped to 88.2% as of 7:35 p.m. ET, up from about 49.2% a week earlier, according to the CME Group's FedWatch tool.

The Fed lowered the federal funds rate in July and September, citing slower global growth and continued trade uncertainty as two key risks it wants to provide a cushion against.

Many investors have expected the Fed to cut rates again at least once this year, though futures markets were previously split on whether the Fed might pull the trigger at its Oct. 29-30 meeting or wait until its Dec. 10-11 decision.

The odds of a cut in October have moved up sharply in recent days, partly due to the Oct. 1 release of an Institute for Supply Management report showing that the U.S. manufacturing sector fell deeper into contraction territory in September.

Those worries heightened on Oct. 3, when the ISM's nonmanufacturing index saw a sharper-than-expected slowdown, falling to 52.6% in September from 56.4% in August. A reading above 50% indicates expansion.

Although the nonmanufacturing index remains in expansion territory, the softer reading suggests "weakening in the U.S. is no longer isolated to the factory sector" and increases the odds of an October cut, Wells Fargo Securities senior economist Sarah House wrote in a research note.

Fed officials have declined to explicitly commit to more rate cuts this year but have not ruled out further easing.

At a Wall Street Journal event in New York, Fed Vice Chairman Richard Clarida said the central bank takes its meetings "one at a time."

"We're not on a preset course, but we will act as appropriate to sustain the low unemployment rate, solid growth and stable inflation," Clarida said.

The U.S. economy is in a "good place" right now, with consumers providing much of the strength, Clarida said. But Fed officials have "been attentive" to the concerns about slower global growth, which were a major factor behind the Fed's July and September cuts, he said.

The central bank has been divided over its next move, with a couple of officials favoring aggressive easing, some cautioning against any rate cuts and others somewhere in the middle.

Chicago Fed President Charles Evans, who has supported the Fed's easing this year, said Oct. 1 the Fed "might need to do more" if risks to the economy increase.

At an Oct. 3 event, Dallas Fed President Robert Kaplan said he also has an "open mind" about the central bank's next move, according to Reuters. He said the Fed would be waiting too long if it waited to act until it sees the weakness in manufacturing "seep into other parts of the economy," Reuters reported.

Unlike Evans, Kaplan does not vote on the rate-setting Federal Open Market Committee this year. Kaplan will rotate into an FOMC voting spot in 2020.