Written by Convera’s Market Insights team
Big cut, modest reaction
George Vessey – Lead FX Strategist
The most highly anticipated Fed decision in years, was arguably a slight disappoint for traders expecting more of an upbeat market reaction. The US central bank went bold, by lowering its benchmark rate by a jumbo 50 basis points to a new target range of 4.75%-5.0%. It was the first rate cut in more than four years and the biggest in sixteen years. Equities rallied to all-time highs, short-dated bond yields slid, and the US dollar index touched fresh 14-month lows. But after some initial volatility, markets reverted course like nothing happened after a more balanced Fed Chair Powell tempered the risk rally.
Powell wanted to reframe the 50-basis point cut as something positive. As a precautionary measure instead of something the FOMC has done because they are behind the curve on the labour market. As well as the jumbo cut, the median dot plot was lowered to indicate two additional 25 basis point cuts over the course of the next two meetings. This would leave the policy rate at 4.25% – 4.50% at the end of the year, still above market pricing. The forecast for the unemployment rate (2024) was revised up to 4.4% while the headline inflation projections were lowered to 2.3%. Something important to note is that Governor Bowman dissented though – the first one from a Governor since 2005. This points to a crack in the Fed’s united front that we haven’t seen in nearly two decades and is further highlighted by the fact that a large majority only sees one cut as their base case for 2024, diverting from the median dot plot of two cuts.
Ultimately, the FOMC is less dovish than the official statement would indicate and we see more room for dissent going into the last two decisions of the year. Powell’s choice to go big shows the Fed is more focused on market stability than internal consensus. It’s a high-stake balancing act. Despite the rewind in markets, we still believe the broader picture continues to support the dollar bearish narrative, that is – interest rates in the US will come down faster than in other countries.
Pound pares gains but BoE could support
George Vessey – Lead FX Strategist
Thanks to the jumbo Fed cut, the pound propelled to fresh 2-year highs versus the US dollar. But after the announcement GBP/USD sharply reversed course from $1.33 as the dollar erased losses thanks to a measured and tactical Jerome Powell. Next up is the Bank of England (BoE) decision today, where we expect Bank Rate to stay at 5% given the data and messaging since the last meeting in August. But because this is also what markets expect, the pound’s reaction might be limited in this scenario.
Still, we think the pound may continue to be one of the most resilient currencies against the US dollar given interest rate differentials between the UK-US are widening. The BoE also seems more focused on inflation concerns compared to the Fed. The jump in UK core and services inflation prints published yesterday resulted in market pricing of a BoE rate cut halving from around 30% to 15% yesterday and total easing by year-end was trimmed slightly from 54bps at the start of the week to 48bps. But while we expect the BoE to stand pat today, we don’t think the latest inflation report will deter it from cutting rates in November, because services CPI has been noisy lately, and the uplift was largely down to base effects, and price categories the BoE seems to care less about. Combine this with the fact UK wage growth is cooling and economic activity is moderating and barring any major upside surprises over the next month, we think back-to-back cuts in November and December are likely.
Overall, GBP/USD continues to move in lockstep with the path of expected rate differentials between the UK and the US this year and we think the Fed’s outlook holds more sway over the direction of travel for the UK currency, especially given its pro-cyclicality and high beta to risk. As a result, and absent any exogenous shocks, the path of least resistance looks higher, with $1.33 expected to be tested again soon.
Euro finds renewed strength post FOMC
Ruta Prieskienyte – Lead FX Strategist
The FX market appeared to overestimate the euro’s potential in the lead-up to the FOMC decision. Initially, the euro surged to $1.119 following the announcement of a significant 50bps rate cut by the Fed, but the move was quickly reversed, with EUR/USD failing to break the key $1.12 resistance level – a 30-month high. This morning the euro is giving another crack at it, climbing over 0.5% ahead of the US initial jobless claims report. European stocks are rallying, and rates are marginally lower, following UST movements.
In line with expectations, 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. Regionally, inflation eased in major European economies, with only marginal increases in Latvia, Malta, Slovakia, and Finland. These figures align with the ECB’s updated forecasts, which project inflation averaging 2.5% in 2024 before falling below 2% by 2026.
With inflation cooling and the Eurozone labour market relatively weaker than the US, there may be growing pressure on the ECB to consider frontloading rate cuts, especially following the Fed’s successful 50bps cut without unsettling the markets. However, an October rate cut seems unlikely, as several ECB policymakers have expressed reluctance to engage in consecutive cuts. ECB’s Nagel, one of the more hawkish members, emphasized the need for patience, citing persistently high services inflation and signalling that gradual rate cuts, rather than an aggressive approach, may be the preferred course of action among the Governing Council members.
Canadian dollar gains on the back of Fed cut
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: September 16-20
All times are in BST
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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.
