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Cautious Fed expected today

Fed projections in focus. Sterling wavers after UK inflation. Collapse in business confidence.

Written by Convera’s Market Insights team

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Fed projections in focus

George Vessey – FX Strategist

Another 25-basis point rate cut from the US Federal Reserve (Fed) is expected later today. Markets are pricing in a 95% probability of such a move, therefore any volatility in the wake of the meeting will likely be a result of the Fed’s dot plots and updated economic projections. Due to the hawkishness expected, any dovish surprise could weaken the USD, especially given its 6% rally so far this quarter.

Market participants are largely expecting a hawkish outcome due to ongoing US economic resilience and the prosect of fiscal stimulus by President-elect Donald Trump. This week alone has seen US composite PMI rise to its highest since March 2022, led by a surge in services. Retail sales increased 0.7% m/m in November, following an upwardly revised 0.5% rise in October and above forecasts of 0.5%. All of this points to robust consumer spending and business activity. As a result, market expectations for further rate reductions next year have been scaled back and with the assumed path forward for US interest rates well above the Fed’s current dot plot, it raises the bar for additional easing.

Moreover, US policy makers have probably gotten ahead of themselves when it comes to their lenient inflation assessment. In September, only three FOMC members saw upside risks to core PCE. We expect the assessment to shift to the upside as the Fed prepares to pause its easing cycle in January. However, if upgrades to the 2025/26 forecasts aren’t as aggressive as what is priced in, the USD may come under selling pressure.

Chart of Fed's inflation assessment

Sterling wavers after UK inflation

George Vessey – FX Strategist

The pound pulled back from yesterday’s highs against peers after headline UK inflation for November was bang in line with forecasts this morning. UK core inflation is the highest in three months, but a measure of services inflation, closely watched by Bank of England (BoE) officials, was a touch lower than expected. GBP/EUR has given up the €1.20 handle once again, whilst GBP/USD has dipped back under $1.27.

The inflation figures this morning were the last big data set ahead of the BoE’s last policy meeting of 2024 on Thursday. Yesterday’s strong wage growth number caused traders to slash bets on BoE interest rate cuts next year, with markets currently pricing in two reductions in 2025, from three as recently as Monday. However, despite higher pay growth, and sticky inflation, there are cracks starting to show in the labour market and activity data suggests the UK economy is slowing. In other words, stagflation fears are increasing. This is why sterling might not be supported as much from higher UK rates in the future.

UK 10-year bonds are the worst performers this year among G10 peers, with yields up nearly 100bps. The pound has been the best performing G10 currency for most of 2024, up until the US election – when the US dollar started to dominate.

Chart of UK inflation

Collapse in business confidence

Boris Kovacevic – Global Macro Strategist

The euro fell below the $1.05 mark once again as US macro data surprised to the upside and German political uncertainty reached another record high in November. Both of Europe’s largest economies are in a fiscal deadline as their governments have either collapsed or remain in the minority. France is expected to expand modestly by 0.2% in the first half of 2025 according to the Insee institute. While not a base case, Germany is in danger to contract for a third consecutive year in 2025.

This is reflected in the sentiment data. The Ifo institutes business confidence fell more than expected in December, reaching the lowest level since May 2020. Four points stood out for us in the survey: 1) The cyclical upside bias from global manufacturing bottoming has not helped the German industry recover. 2) The divergence between the Ifo index and GDP shows a high probability of structural change and a regime change happening within the German economy. 3) German businesses have never been this pessimistic for such a long period of time. 4) The expectations and current situation sub-indicators have converged, meaning that the former will be more important to watch as a sign of a turnaround.

The political news flow surrounding Germany and France and today’s FOMC decision will be key catalysts for the euro. A sustained break of the $1.05 level into the weekly close could spell trouble for the currency.

Chart of German policy uncertainty

Gold down almost 3% in a week

Table: 7-day currency trends and trading ranges

Table of FX rates

Key global risk events

Calendar: December 16-20

Table of risk events

All times are in GMT

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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.

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