Written by Convera’s Market Insights team
Fed rate cut ahoy
George Vessey – Lead FX Strategist
This Wednesday, the US Federal Reserve (Fed) is set to join other central banks in reversing some of the steep post-pandemic hiking cycle. The US dollar has come under increased selling pressure of late, falling to near its weakest level in over a year as traders progressively lean toward a 50-basis point cut rather than a standard 25bp cut.
Traders boosted bets on a larger, half-point cut despite some upside surprises in inflation data last week. The theory is the Fed doesn’t want to get behind the curve as it tries to manage a soft landing and avoid a bigger hit to the labour market. However, some argue a jumbo cut would be an overreaction and that the economy isn’t in urgent need of looser monetary policy. As markets are pricing, it will likely be a close call, and there will probably be members of the FOMC who will vote for a 50bp cut, but our base case is a quarter point move. However, even a dovish 25bp move could lead to extended dollar weakness, particularly against the Japanese yen given the Bank of Japan is expected to hike rates again before year-end.
The over 2% decline in USD/JPY last week has continued this week, with the pair advancing past the closely watched 140 level as investors bet on narrowing interest rate differentials between the US and Japan. This has been the major drag on the dollar index overall, which could soon test its 200-week moving average support level at 100.4.
Inflation and BoE in focus
George Vessey – Lead FX Strategist
Recent labour market and activity data continue to point to a resilient UK economy with fairly slow disinflation versus peers, which has supported the pound’s growth and yield differential appeal. GBP/USD remains four cents above its 2024 average of $1.27 whilst GBP/EUR remains over one cent above its year-to-date average of €1.17.
Markets largely expect the Bank of England (BoE) to keep UK rates on hold this week, but underwhelming figures from last week’s GDP report for July have slightly increased the odds of a cut. The case for a slow and relatively shallow cutting cycle by the BoE remains intact for now, but the focus this week shifts to the August UK inflation print on Wednesday ahead of the BoE’s policy meeting on Thursday. The inflation report is expected to show an uplift in the BoE’s important services inflation measure, supporting the view that the UK central bank will be treading more carefully when it comes to rate cuts. We do expect the BoE to hold Bank Rate unchanged at 5%, in line with money market pricing and a unchanged vote split of 8-1 in favour of the decision. But any changes in the vote split towards a rate cut could trigger GBP weakness.
Meanwhile, as we’ve stated previously, the new UK government’s intention to pursue a closer EU-UK relationship should offer structural support to the pound, but in the nearer term, potential headwinds linked to the upcoming Budget and the possibility for perceived anti-growth measures do present another downside risk to sterling’s outlook.
Euro bulls gearing up for first Fed cut
Ruta Prieskienyte – Lead FX Strategist
Despite a weak start to September, typically an unfavourable period for the euro, EUR/USD has rebounded above the $1.11 level, gaining over 0.6% month-to-date. This recovery has been supported by a less dovish-than-expected ECB and growing expectations of more aggressive easing by the Fed. Last week’s 25bps ECB rate cut was coupled with a continued focus on inflation, even as the growth outlook was revised downward. With the ECB now having set a precedent for cutting rates during meetings that include new staff projections, the risks are skewed towards a pause in October and another cut in December. Unless the Eurozone’s economic outlook improves significantly, we continue believe the ECB will be forced to acknowledge rising risks to growth, now most likely at the last meeting of the year, potentially accelerating its rate cut cycle and tempering the euro’s potential.
The focus this week, however, is squarely on the Fed. Market speculation is increasing around the possibility of a half-point rate cut, which could push EUR/USD higher from the current level. This sentiment is evident in the narrowing of the front-end Germany-US yield spread, now at a 16-month low. Even if the Fed opts for a more dovish 25bp cut, signals of further easing could keep the euro supported, as any short-term dollar strength might be reversed by expectations of deeper cuts in upcoming meetings.
In the options market, EUR/USD short-term risk reversals have experienced their sharpest repricing since the August stock market selloff, reflecting increased demand for euro calls. If this trend continues, EUR/USD could trend higher, though resistance at $1.12 remains a key obstacle for now.
JPY up over 2% vs. USD and CAD in last seven days
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.
