Written by Convera’s Market Insights team
Half point cut still expected this year
George Vessey – Lead FX Strategist
The US dollar surrendered its post-CPI gains yesterday as traders upped their wagers on a half point rate cut by the Federal Reserve (Fed) next week. Despite some upside surprises in both core consumer and producer price inflation data seen this week, suggesting a quarter-point cut is more likely, media reports from Financial Times and the Wall Street Journal implied the Fed’s decision would be a close call.
Volatile pricing of Fed rate cutting expectations has been evident all year and the last week has been no different. The probability of a 50-basis points cut at next week’s policy meeting jumped to 40% in the wake of the soft US jobs report last Friday. But the slightly higher-than-expected core US inflation print on Wednesday snapped that probability back to nearly 10%. US yields rebounded along with the US dollar as a result. Yesterday’s economic did little to alter the policy outlook, although we did see an upside surprise in initial jobless claims. But it was later in the evening when former Fed member Dudley cited a slowing US labour market, with risks to jobs greater than lingering challenges to inflation supports a half-point reduction. This saw bets of a jumbo cut jump back to 40%, sending US yields and the dollar lower.
Indeed, the market was always still expecting a 50-basis Fed cut sometime this year given 100 basis points of cuts were still priced in over the next three meetings. The biggest concern for bond bulls and an upside risk to the USD would be a Fed meeting where the central bank shows it is still concerned enough about inflation pressures to tack toward only small, gradual reductions. Amidst this uncertainty and along with the looming US election, implied 3-month volatility for the US dollar is nearly as high as it’s been since the regional-banking crisis in early 2023.
Pound catapults back above $1.31
George Vessey – Lead FX Strategist
It’s all about the Fed at the moment. Although UK yields have fallen for two weeks running, dampening the pound’s appeal, it’s Fed pricing which is dominating the FX space and cross asset price action.
GBP/USD held onto $1.30 after slipping to a 3-week low on weaker UK GDP growth but was catapulted back above $1.31 as bets of a larger rate cut by the Fed next week grew. Although Fed pricing is in the spotlight, UK inflation and the Bank of England’s (BoE) meeting next week will be important for the pound’s outlook. Given the lack of any data materially challenging the current view that the BoE will hold rates steady and since we haven’t heard from any of MPC members since August barring the Governor at Jackson Hole, it suggests policymakers at the BoE haven’t shifted position significantly enough that they wish to communicate it to markets. Any large deviations from expectations in the inflation report ahead of the BoE meeting might change that though, presenting the biggest risk to GBP.
1-week implied volatility, which captures the Fed and BoE meetings, as well as UK inflation, is trading much higher than its 2024 average in a sign that investors are preparing for an increase in GBP/USD fluctuations.
ECB remains hawkish, supporting euro
Ruta Prieskienyte – Lead FX Strategist
The ECB cut the deposit facility rate by 25bps to 3.5%, in line with market expectations. Additionally, the rates on the main refinancing operations and the marginal lending facility were lowered to 3.65% and 3.90%, respectively, effective from September 18th. However, market participants were primarily focused on the new economic projections and the post-decision press conference.
In terms of projections, the inflation forecast remained unchanged at 2.5% for 2024, 2.2% for 2025, and 1.9% for 2026, though a short-term rise in inflation is anticipated as the effect of earlier energy price declines fades. Core inflation is expected to drop from 2.9% in 2023 to 2.0% by 2026, despite slightly elevated services inflation. On the growth front, the ECB revised down its forecasts by 0.1 percentage points for 2024, 2025, and 2026, reflecting weaker growth prospects. Despite acknowledging downside risks, President Lagarde and the ECB maintain confidence that momentum will improve, driven by a recovery in real incomes, though this has remained a weak spot thus far in 2024. Service inflation remains a concern for the committee, posing an ongoing risk to the inflation outlook.
As expected, the ECB’s guidance remained unchanged, emphasising a data-dependent approach and an unwillingness to pre-commit to a specific rate path. The overall message from the ECB was mixed, but not overtly dovish, providing some relief to euro assets. Stocks advanced, bringing the week-to-date gains closer to 2%. Bunds sold off across the curve, and with rising yields and a marginal narrowing of the front-end Bund-UST spread, EUR/USD rebounded slightly from its three-week low. Rate cut expectations for the ECB’s October meeting increased from around 35% the day before to 55%, though volatility remains high. Traders are increasingly uncertain about whether the ECB will proceed with another cut in six weeks’ time, given the central bank’s focus on inflation despite deteriorating economic growth.
Swissy on the back foot this week
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: September 9-13
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.
