September 18, 2024

“Today’s Federal Reserve decision is the most significant policy decision in recent memory. Powell is set to deliver the first US rate cut since hiking dramatically in the past few years, and markets have virtually zero certainty on whether it is going to come in a 25bp or 50bp hit. The addition of a fresh dot plot and a difficult communication challenge means that FX is set for some big shifts.”

Tim Hallinan – Trading Director

USD

It rarely gets more interesting than this evening’s Federal Reserve decision, and it is difficult to overstate just how close a call it is between a 25bp or 50bp start to the easing cycle. Bloomberg have stated that the markets have not been this split on an FOMC decision since 2007 – for BofA, there is a record low amount of clarity priced into the futures curve. Broadly, a 25bp cut should lever up US yields and boost the dollar, while a 50bp cut would further endorse the market’s aggressive cut expectations and take the greenback lower. However, communication will be critical. There are too many possible permutations to list here, but a 25bp move could be accompanied with either some strong hints that multiple 50bp moves are coming, or with a surprisingly cautious stance that leads to several future cuts being priced out in the rates markets. And if it’s 50bps, there is likely to be a significant amount of rhetorical cushioning, so as not to inject recession fears and send risk assets tumbling. Overall, it isn’t the 25bp difference itself between the options that is critical for the dollar – it’s how each sets the tone for the next year or two.

GBP

Sterling has found some support this morning after the August CPI report effectively closed the door for a Bank of England rate cut tomorrow. The survey estimates were spot on for the key figures, and we got 2.2% for headline inflation, 3.6% on the core measure, and 5.6% in services. Given the focus on the medium-term persistence of inflation, it’s the uptick in the latter that is likely to be enough to prompt policymakers to stick to a once-per-quarter pace of rate cuts, meaning we’ll likely have to wait until November for the second move. Markets still price a residual 15% chance of a cut tomorrow, but it is certainly an off-consensus call.  For today, watch the Fed.

EUR

The euro managed to shrug off a surprisingly poor ZEW sentiment figure yesterday. Fading optimism about a near-term economic recovery dragged the index for Germany down to 3.6, which is the lowest since October last year when anaemic eurozone growth helped to drag the euro down below 1.05. But the FX markets have become somewhat desensitised to reminders of the bleak economic outlook in Germany – it is well priced in. The soft activity outlook was not enough to convince the ECB’s Simkus that there was any decent chance of another rate cut in October, however, and he argued that the likelihood is very small. There is no big domestic data in the eurozone today, but there are likely to be some big shifts across markets after the Fed decision, both versus the dollar through the US rates channel, and on the crosses via the risk channel.

Markets

The Dow and the S&P 500 both touched fresh record highs during the session yesterday on the back of a relatively strong retail sales report, but ultimately ended the day flat as caution appeared to set back in ahead of the Fed rate decision. Trading is likely to be subdued throughout today, until traders are able to take cues from the Fed’s economic assessment.

Main Economic Events (All Times CET)

8:00am: UK CPI
2:30pm: US Housing Starts & Building Permits
8:00pm: Federal Reserve Rate Decision

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