Written by Convera’s Market Insights team
Coin-toss decision in focus
George Vessey – Lead FX Strategist
The US dollar received some welcome support after US retails sales unexpectedly edged up 0.1%, compared to forecasts it would fall 0.2% m/m in August. The report failed to settle the debate on the size of the Federal Reserve (Fed) interest rate reduction today though, with pricing holding steady in favour of a half point cut versus a quarter point cut.
Despite the upside surprise in the headline figures, the three-month moving average of retail sales data suggests that spending has been losing steam this year compared to 2023. The average monthly increase has dipped to 0.13% this year from 0.46% last year. Moderating spending, falling inflation and the growing downside risks to the labour market, point to the Fed being dovish today and confirming that this is just the beginning of the easing cycle. There is a sense that markets are pushing the Fed into a jumbo cut too, i.e. if markets price this in more, the Fed is more likely to deliver it. If so, the dollar’s trajectory is likely lower, and we could witness fresh multi-year highs for the pound, euro and yen soon.
However, could this be one of the few meetings where Fed policy will not validate the market? Some Fed policymakers will likely be resistant to such an aggressive start to the easing campaign with the US economy still growing strong, unemployment low, inflation above target and equities at all-time highs. So, a 25-basis point cut is still a possibility in our eyes, and this could temper USD weakness in the short term.
UK inflation in line with expectations
George Vessey – Lead FX Strategist
UK inflation data for August came in line with expectations. The annual increase in CPI held at 2.2%, above the Bank of England’s (BoE) target for a second month running. Core CPI rose to 3.6% from 3.3% and services CPI, the BoE’s preferred measure, jumped to 5.6% from 5.2% as expected. The British pound has strengthened slightly following the data release with GBP/USD back in the upper realms of $1.31 and GBP/EUR steady in the mid-€1.18 region.
Given the data came in line with the consensus forecasts, and the uptick in core and services driven mainly by base effects and volatile hotel prices related to Taylor Swift’s tour, it is unlikely to sway materially the BoE’s monetary policy decision on Thursday. Policy makers are largely seen keeping rates on hold at 5% with markets pricing in just a 25% chance of a rate cut. With average weekly earnings slowing in July and moderating activity data raising some concerns about the health of the UK economy, we suspect inflation will become less of an issue and the BoE to embark on its easing cycle in November. All eyes are the size of the Fed rate cut though and its guidance on the pace of easing going forward, which may influence the BoE’s policy path.
What does this mean for sterling? For now, rate differentials favour the pound as the BoE is still seen as the least dovish G3 central bank over the next couple of years. But the risk to this assumption is if the BoE pushes back against market pricing and takes on a more dovish approach. Overnight volatility in the pound has risen to its highest since August 2023 as traders position ahead of the policy decisions by the Fed and the BoE.
Euro shrugs off ZEW plunge
Ruta Prieskienyte – Lead FX Strategist
The euro edged lower but remains above the key $1.11 level as markets anticipate the Federal Reserve’s meeting tonight, with debate intensifying over the prospect of a larger 50 basis point rate cut. European stocks and bonds experienced a reversal in dynamics when compared to the start of the week, with the Stoxx50 equity index gaining nearly 0.7% on the day, while bonds retreated, mirroring the global trend.
On the macro front, 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. Despite these deteriorating indicators, the ECB remains in no rush to accelerate its easing cycle, with several Governing Council members, including ECB’s Simkus, signalling that the December meeting is the most likely point for a third rate cut. The probability of a cut in October is considered very low, with OIS curve pricing ~30% probability of such an event.
In the options market, sentiment has turned more bullish for the euro ahead of the Fed decision. One-week EUR/USD risk reversals are increasingly skewed in favour of euro calls, with the spread reaching close to 0.7 vol—the most bullish euro pricing in nearly four years. While a smaller 25 basis point Fed cut could lead to some profit-taking on the euro, this is more likely to limit further dollar weakness than cause a significant reversal in the euro’s trajectory.
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Calendar: September 16-20
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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.
