Written by Convera’s Market Insights team
Dollar at 4-month low after dovish Fed
Boris Kovacevic – Global Macro Strategist
The Federal Reserves most aggressive tightening cycle in four decades is officially over. The US central bank left policy rates unchanged at 22-year highs for a third consecutive time, cementing the narrative of peak interest rates and igniting a global cross-asset rally and FX capital allocation away from the dollar. The closely watched dot-plot showed the Fed’s intention of cutting interest rates three times next year and more than markets had anticipated. In combination with Chair Jerome Powell not pushing back against the recent easing of financial conditions and emphasizing the positive development on the inflation front and easing labor market conditions, markets took that as a nod to continue pricing in more policy easing in 2024. The reaction to the Fed’s rate projection and press conference has been extreme.
Investors are now expecting the Fed to start cutting interest rates in March with a 70% probability and price in six rate cuts for the next year. Global equities and government bonds rallied together with all three US stock benchmarks rising by well above 1% on the day. The S&P500 inched closer to its all-time high and is now only 2% away from reaching a new record. The US 10-year yield fell below the 4% mark to a 4-month low, pushing down the US dollar against most currencies. USD/JPY is on track to record its fifth consecutive weekly decline, having fallen by 6.4%. The currency pair has acted as the proxy of the monetary policy divergence story with the Feds next move expected to be a cut, while the Bank of Japan is preparing to raise interest rates.
Markets have been positively surprised by the rate decision and following press conference. The lack of pushback against the priced in rate cuts is unusual, especially against the backdrop of leading inflation indicators starting to point up again. The 200 basis points of cuts are the most markets have ever priced in for the Fed for the upcoming 18 months. Now, the data will be the deciding factor on whether these expectations materialize in 2024. The US dollar fell against every single currency within the G10 category. However, today’s BoE and ECB meeting will be crucial for the euro and the pound. The last time these two central banks set policy a day after the Fed, both currencies appreciated following the Fed decision, but weakened after the press conferences of the BoE and ECB.
BoE to push back against 125bp of cuts?
Boris Kovacevic – Global Macro Strategist
The Federal Reserve meeting has not gone unnoticed in other parts of the world with investors pushing up their expectations of the Bank of England cutting interest rates five times next year. The surprisingly dovish Fed decision will definitely make it easier for other central banks to pivot monetary policy once inflation has come down enough to do so.
The recent string of data out of the United Kingdom had been surprisingly weak, with wage growth, employment growth, GDP and industrial production all falling more than expected. The British pound gave up the $1.27 levels last week after a strong US labor market report, with GBP/USD briefly trading below $1.25. However, the weaker macro data this week has been completely overshadowed by the dovish pivot from the Fed, pushing the currency pair to $1.2640 once again. Reaching the multi-month highs at $1.2730 will only be achievable if the BoE pushes back more against these rate cutting speculations than the Fed. This should not be too hard for British policy makers with wage growth and core inflation still above 7% and 5% respectively.
Markets will pay close attention to comments surrounding the labor market, which has recently started to cool. The number of payrolled employees fell by 13 thousand las month and the claimant count rose by 16 thousand in November. Job vacancies are cooling, and wage growth tracked by alternative measures has been moderating as well. As of now, it will be important for the pound that the BoE maintains the expected policy rate differential for 2024 at current levels.
Euro gains after dovish FOMC, ECB next
Ruta Prieskienyte – FX Strategist
The euro advanced above $1.09 level following the Fed’s decision to keep interest rates unchanged and hinting at three 25bps rate cuts over the course of 2024 – well below the previous projections. EUR/USD was little changed ahead of the FOMC event as weak eurozone industrial production was offset by weaker than forecasted US PPI data. Eventually the pair closed 0.8% up on the day to a fresh 2 week high. Now investors await the European Central Bank (ECB) policy rate decision later this afternoon.
The ECB is also widely expected to keep rates unchanged but is in the most difficult position trying to keep its options open without losing credibility. The latest data on inflation and growth continued to undershoot ECB’s September projections, while credit data reflects tighter financial conditions continuing to feed through into the real economy. Since the September hike, markets have continuously brought forward their expectations of rate cuts into early next year and expect rate cuts to begin as soon as March, for a current total of 145bps by the end of 2024. We expect Christine Lagarde to push back against rate cut speculations in Q1 but will be looking for a partial shift in tone after the update of ECB economic projections followed by a further shift over the course of Q1 as some remaining inflation risks dissipate. However, it would not come as a surprise if the Governing Council temporarily sticks to a hawkish stance as this would be in line with previous cycles to prevent an unwarranted and premature easing in financial conditions, thus undoing some of the work.
In the aftermath of the FOMC, hourly EUR/USD RSI pointed to an overbought territory, thus we would expect price pullback in the very short term ahead of the ECB rate decision. However, longer horizon momentum indicators show there is room for more upside movement and EUR/USD could test $1.0900 – $1.0950 level. On the flip side, immediate support is seen at 1.08713, followed by 200-day SMA at $1.08271.
CAD strengthens as Fed signals rate cuts in 2024
The Canadian dollar broke past the $1.3500 level against the US dollar as FOMC’s delivered a dovish tilt and gave markets the clearest signal yet that its aggressive hiking campaign is finished, pencilling in 75bps cuts for 2024. As result USD/CAD fell to a fresh 2-month low and is trading around $1.3450 ahead of the New York session.
However, intraday bias for USD/CAD remains to the downside as markets continue to digest FOMC decision with resistance at 200-day SMA at $1.3511. However, the momentum will weaken as RSI technical indicator points to oversold conditions. With BoE and ECB up next, GBP/CAD and EUR/CAD could also see further weakening if the remainder of the G3 central banks catch Fed’s dovish contagion.
DXY hits 4-month low on dovish Fed
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: 11 – 15 December
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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.
