Global equity markets are approaching all-time highs as investors move capital to riskier assets and away from the US dollar. Short-term yields are down in anticipation of more policy easing, leading the yield curve to steepen further.
The Federal Reserve commenced its long-awaited easing cycle with a 50 basis point cut. The move was favored by markets but came to a surprise to most economists, who had penciled in a smaller move. Uncertainty about the policy path remains high.
The extent of further easing will be decided by the magnitude of the labor market slowdown and path of inflation. Consensus building will be a tricky task for Jerome Powell and another close decision for November is likely.
The BoJ and BoE left policy rates unchanged but display different biases. Japanese policy makers are still expected to raise interest rates, while British central bankers could cut rates one or two times this year. Policy divergence is the name of the game.
Europe struggles with a negative news flow coming from its largest economy as sentiment data starts to worsen again. The ECB is seen as unlikely to move in October, but we won’t close the possibility of a cut completely.
USD is bracing for a breakdown lower as the currency hit a 14-month low this week. The gravitational pull from lower rates is proving strong for the Greenback.
Next week will be a crucial one. Leading indicators like the Ifo Index and PMIs will set the scene, while some central banks are set to ease policy further.
Global Macro
What we know about the Fed
The Federal Reserve cut its benchmark policy rate by 50 basis points, lowered its inflation projections and increased its forecast for the unemployment rate. The dot plot got revised down to imply further easing worth 50 basis points over the next two meetings. This is what we can likely imply from that information for now:
(1) Preemptive. The front loading of the easing cycle is seen as a preemptive measure to increase the odds of a soft landing and to not get stuck behind the curve when it comes to the labor market.
(2) Markets thirsty for more. Powell pushed the large cut over the line with the help of the market. This has given investors the green light to push for more easing as early as November. Wall Street is reading between the lines: if the Fed’s willing to cut 50 now, why not again in November?
(3) Dissent. Governor Bowman’s dissent is seen as a crack in the Fed’s united front. A large minority only sees one cut as their base case for 2024 as well, diverting from the median dot plot of two cuts. We see more room for dissent going into the last two decisions of the year.
(4) Shifting focus. The press conference and individual assessments of FOMC members, implied by the dot plot, signal a clear shift in risk management and perception from inflation to the labor market. The latter remains the sole determinant of Fed policy as long as inflation remains anchored. However, the macro uncertainty and data dependency will continue to plague investors and keep them guessing the Fed’s next move.
Global Macro
Diverging policy
More easing in the US. The Fed believes the disinflation trend remains in place and see making unemployment their top priority as the labour market has weakened. In the immediate aftermath of the decision, the risk rally fizzled out as Fed Chair Powell cautioned against assuming big cuts would continue though. Still, there was a big shift lower in the Fed’s predictions for where US interest rates will be at the end of this year and next. Markets still see another 70bps of easing before year-end, versus the Fed’s expected 50bps. Treasury yields are higher across most of the curve but with long-end yields rising faster, this means Treasuries are bear steepening and this has restrained the risk rally somewhat.
Tightening bias in Japan. The Bank of Japan left interest rates unchanged at 0.25% after tightening policy two times already this year. Speculations remain over another rate hike at the end of the year as price growth continues to surprise to the upside. Inflation rose from 2.8% to 3.0% in August, reaching the highest level since October 2023. The divergence between the Fed and BoJ puts a bearish bias on USD/JPY, but Japanese stocks seem to benefit from the goldilocks scenario of lower rates and the soft landing playing out in the US.
Steady rates in Britain. The Bank of England (BoE) left its interest rates unchanged as expected on Thursday. The Monetary Policy Committee voted by a majority of 8–1 to maintain Bank Rate at 5%. BoE Governor Andrew Bailey’s emphasized the requirement for policy to stay restrictive for “sufficiently long” and that most members saw the need for a gradual approach to removing restraint. However, the rising prospect of tighter fiscal policy at the upcoming Budget could stifle UK growth prospects and might spur a dovish recalibration in the BoE policy outlook.
Regional outlook: Eurozone
Sentiment plunges to a near 1-year low
ZEW disappoints. The ZEW Indicator of Economic Sentiment for Germany in September sharply disappointed, falling to 3.6—the lowest level since October 2023—down from 19.2 in August. The current conditions index also dropped to its lowest since May 2020, falling to -84.5 from -77.3 in the previous reading. Similarly, the Eurozone-wide ZEW measure plummeted to an 11-month low of 9.3, far below forecasts of 16.3, reflecting ongoing uncertainty around the economic outlook and the direction of monetary policy.
August inflation in line with preliminary estimates. The final annual inflation rate in the Eurozone matched preliminary estimates, easing to 2.2% in August, down from 2.6% in July—the lowest since July 2021. Services prices contributed most to inflation (4.1% vs. 4% in July), while inflation slowed for non-energy industrial goods, and energy prices declined. Core inflation also slightly eased to 2.8% from 2.9% the previous month.
Should ECB follow in Fed’s footsteps? Fed Chair Powell successfully delivered a 50bps rate cut without triggering market panic, which now raises the question of whether the ECB may follow suit and frontload rate cuts. With inflation in Europe cooling, the labor market showing relative weakness, and economic growth tepid at best, pressure may start mounting on the ECB to consider more aggressive easing measures. However, an October rate cut remains unlikely, with only 6bps priced in by the markets, largely due to resistance from the ECB’s hawkish faction, which has discouraged back-to-back cuts. Looking ahead, the tone within GC could shift by December, the last meeting of the year, especially if data continues to weaken. The very early signs of this potential change in stance are there. For instance, ECB’s Centeno, known for his dovish views, hinted that the ECB may need to accelerate rate cuts to prevent inflation from falling below target. If the central bank leans toward more aggressive cuts, Bund yields could fall, creating a headwind for the euro heading into year-end.
Week ahead
Fed gives the world green light to cut
The Federal Reserve has given other central banks the green light to proceed cutting interest rates and has ignited a somewhat delayed risk-on rally. With equity benchmarks at record high, the first test following the FOMC decision will come in the form of PMIs, German sentiment data and European and US inflation figures. A lot to digest for markets, which are gearing up for the rate decisions in Australia, Sweden and Switzerland.
All eyes will be on the inflation print coming up in the United States. The CPI and PPI readings suggest that the Fed’s preferred inflation measure (PCE) just grew by 0.2% in August. This would be consistent with the 2% target and could boost confidence in more rate cuts to come.
The Swiss National Bank is expected to ease policy for a third time this year as inflation remains subdued and the franc continued to display strength. Markets and economists are split on the magnitude of the easing with a 25 and 50 basis point cut being floated. In Sweden, the Riksbank could follow suit and cut rates for the third time as well. This would underline the easing bias in Europe as inflation continued to come down and growth remains sluggish. The Reserve Bank of Australia remains one of the last hawks standing, which is expected to leave rates unchanged next week. However, the recent weakness in GDP and a downside bias on inflation mean that the argument for a hike is receding. Inflation is expected to have fallen from 3.5% to 2.7% in August.
On the macro front, sentiment data from Germany will be crucial to gauge how much the recent negative news flow regarding the countries largest companies has impacted investors and businesses mood.
FX Views
Policy divergence punches US dollar
USD Bracing for a breakout lower. A relatively hawkish jumbo Fed cut sparked some volatility into FX markets this week, with the dollar index hitting a 14-month low before finding support at its 200-week moving average. After a brief relief rally, the dollar’s downtrend resumed though as it seems markets are preferring to err on the dovish side, pricing in more rate cuts over the forecast horizon than the Fed is projecting. The recent bear steepening of the yield curve, with long-end rates rising faster than short-end is usually associated with a weaker dollar, and that’s what we’re seeing. The key question now is whether the USD is going to break out lower from its 2-year trading range. With cable above $1.33, EUR/USD approaching $1.12, and USD/JPY testing 140 recently, the DXY looks primed to fall below its key 100 level soon, a move which may accelerate the downtrend.
EUR Political risks may cap potential. It appears that euro bulls got ahead of themselves in the buildup to the first Fed rate cut. While the pair briefly touched $1.118 twice at the end of the week, a less dovish-than-anticipated Fed stance, combined with deteriorating Eurozone fundamentals, caused the rally to stall. Despite multiple attempts, EUR/USD has struggled to break above the $1.12 level, excluding 6 days in July 2023. This ceiling seems well-defended for now. The euro may make another attempt toward this level if US data continues to show labor market weakness, which could prompt concerns about whether the Fed has responded fast enough. However, without more material signs, focus will soon shift to the next significant event—namely, the US election. Historically tight odds between the candidates could heighten uncertainty, adding downside risks to the euro. Rising FX volatility around US elections has often negatively correlated with EUR/USD spot returns. Additionally, political and fiscal issues in the Eurozone, particularly in France, add to the euro’s challenges. France missed a deadline to present a credible plan to reduce its debt and deficit, creating further uncertainty. This has widened the 10-year OAT-Bund spread to over 74.7 basis points, a month-high, and could weigh on the euro if no resolution is reached soon. These combined factors suggest that while the euro has upward potential, significant risks may limit its rise.
GBP Propelled by policy divergence. The British pound continues to defy weak seasonal trends, up 1.5% versus the US dollar so far this month. GBP/USD has hit a fresh 31-month high above the $1.33 handle thanks to diverging monetary policy paths by the Fed and BoE. The BoE left interest rates unchanged this week, which has left market pricing of further easing relatively light compared to the Fed and most other major economies in cutting cycles. As such, the 2-year real rate differential between the UK and US has climbed 10 basis points this week to a new 1-year high, supporting the pound. The better-than-forecast UK retail sales for August only reinforced its conviction to clip fresh 2-year highs against the dollar and against the euro. One could argue that little BoE easing priced into markets leaves GBP vulnerable though, especially since CFTC data suggest investors are already bullish. But overall, we think the currency should still benefit from a coordinated easing cycle where the US avoids recession, due to its pro-cyclicality and high beta to risk. One particular headwind looms though, the rising prospect of tighter fiscal policy, dampening the UK growth outlook and potentially triggering a dovish recalibration of BoE policy, which could punish the pound.
CHF Pressure is mounting. The franc is headed for its worst week in five against the euro as investors increase bets that the Swiss National Bank might cut interest rates by 50 basis points next week. The Swiss currency has strengthened almost 5% against the euro and 9% against the dollar since the end of April to near the strongest levels since 2015. This is a breakneck pace of appreciation that has tightened monetary conditions in the domestic economy — running counter to the central bank’s policy loosening. Switzerland’s real-effective exchange rate is far from cheap, so the SNB is closer to the point where it may become less tolerant of a stronger currency. While markets expect another rate cut, it’s the SNB’s language on the franc that will be worth watching.
CNY PBoC Promises to Take On Deflation Head-on. The Chinese central bank is preparing more steps to combat deflation following August’s less robust-than-anticipated loan growth. Indicating poor loan demand, the M2 money supply increased 6.3% vs the consensus growth of 6.2%, while new yuan loans totaled CNY900 billion versus CNY1.02 trillion. The PBoC has stated that it is “preparing to launch some additional measures, further lowering the financing costs for businesses and households, and keep liquidity reasonably ample,” but it has not really explained what it would do next. The market was unprepared for the sudden move in USDCNH last Thursday, which was fueled by exporters selling. Once the US rate-cut cycle began, one would have anticipated the yuan to underperform relative to peers. It actually outperformed following the Fed’s 50 basis point cut, doing just the opposite with CNH gains of 0.60% vs USD.
JPY Yen watches trade data weakness and BoJ stands pat. Due to imports rising just 2.3% year over year, much below the 15% projected, Japan’s trade deficit for August was JPY695 billion compared to a consensus of JPY1.43 trillion. In spite of a 10.6% consensus and a 10.2% decrease in vehicle shipments, exports increased 5.6% year over year. Japan’s exports decreased 0.7% year over year to the US, 8.1% year over year to Europe, and 5.2% year over year to China, marking the first decline in exports to the US in over three years. The lackluster import and export data points to a slowdown in economic activity, a more difficult external environment, and the early effects of a higher yen. The BoJ have stand pat by maintaining its policy rate at its meeting last Friday. Recent price action suggests USD/JPY is facing a resistance at 144, in a bearish key descending channel trend. Traders should monitor upcoming Tokyo CPIs and au Jibun Japan Manufacturing PMI.
CAD Fails to benefit from Fed. Despite reaching a near three-week high, the Canadian dollar has underperformed its high-beta G10 counterparts, showing minimal movement on a weekly basis and failing to meaningfully benefit from the Fed’s jumbo rate cut. This is largely due to the now synchronized policy direction of both the Fed and the BoC, as both central banks appear to be easing at a similar pace. Last week, the BoC governor indicated readiness for deeper rate cuts should the Canadian economy continue to underperform, which was supported by recent inflation data pointing to downside surprises and a headline figure right at the 2% target. Such harmonisation could neutralize the impact of BoC rate cuts on USD/CAD in the near term. However, the divergence in the expected terminal rates—BoC projected to peak at 2.25% versus the Fed’s expected 2.75-3%—suggests the Canadian dollar may remain structurally weaker once both central banks conclude their current easing cycles.
AUD Aussie dips as inflation expectations ease, RBA policy scrutiny intensifies. While still considerably over the 2-3% RBA target zone, Australia’s September Melbourne Institute consumer inflation forecasts fell to 4.4% from a four-month high of 4.5% in the August poll. Take note that the July official CPI inflation rate was 3.5% y/y. However, the current central bank board came under fire last Thursday from former RBA Governor Bernie Fraser for placing an excessive amount of emphasis on inflation at the detriment of the labor market. He cautioned that there were “recessionary risks” that may have disastrous effects on the economy and recommended that the board reduce the cash rate. AUD/USD bounced from the 0.6633 200-day exponential moving average on Sept 11th, but the overall setup and rejection of broader range resistance still points to further weakness over the near-term. Next key resistance is at 0.70 handle, as Aussie is at Year-To-Date 2024 highs. Traders should monitor the upcoming RBA rate decision, monthly CPI indicator.
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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.
