Fed set to cut rates for second time this year

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18 September 2019

thomasdodds

The main event in the currency markets this week will undoubtedly be tonight’s Federal Reserve monetary policy meeting, in which policymakers in the US are broadly expected to lower interest rates for the second time so far this year.

A
t the time of the most recent cut in July, Chair Powell fell short of indicating that a full-blown easing cycle was on the way, instead claiming that the cut was merely a ‘mid-cycle adjustment’. An escalation in the US-China trade conflict since then has, however, raised expectations that more rate cuts could be coming. Financial markets are currently fully pricing in another interest rate cut from the Fed this week. Given the high expectations for a cut, the reaction in the currency markets is therefore likely to be driven largely by the Fed’s communications regarding future policy and voting pattern among FOMC members.

First of all, we think that the vote on rates will not be unanimous, with some of the more hawkish members of the committee likely to vote for stable rates given the recent solid performance of the US economy. The extent to which members dissent could prove very important. The ‘dot plot’, which shows where rate-setters expect rates to be at the end of each year, will come under heavy scrutiny and may be shifted slightly lower. A ‘dot plot’ that implies one more 25 basis point rate cut by the end of 2019 would be a dovish signal that could trigger a sell-off in the US dollar. A firm hint of additional cuts beyond this year would exaggerate said sell-off.

By contrast, the FOMC may disappoint US dollar bears by merely cutting rates once and indicating that it will be leaving policy unchanged, barring a deterioration in incoming data. Under such a scenario the US dollar would likely rally, given the relatively high expectations for cuts. No rate cut at all from the Fed this week would be a significant disappointment and would undoubtedly cause a sharp appreciation in the greenback, although we think it is pretty unlikely.

All in all, we still expect the Fed to cut rates by 25 basis points this week and maintain its easing bias. While this will not mark a firm commitment to additional cuts, it will keep the door open to further rate reductions in the coming months, should macroeconomic conditions take a turn for the worse.

Sterling rallies on hopes of ‘no deal’ avoidance

In the currency markets on Tuesday, the pound rose by around three-quarters of a percent against the dollar on growing hopes that a ‘no deal’ Brexit will be avoided.

Boris Johnson is now required by law to seek a three month extension to Brexit should no arrangement be reached by 19th October. While Johnson is reportedly actively looking for ways to circumvent it, investors are doubtful that he’ll have the political scope to follow through with his pledge to drag the UK out of the EU come what may on 31st October. This expectation has now seen sterling rally by over 4% in the past two weeks alone.

Next up for the UK currency will be this morning’s inflation numbers, expected to show that consumer price growth slowed back below the Bank of England’s target in August.

Oil price retreat calms markets, buoys euro

The euro rallied by a similar amount to sterling yesterday, lifted by general cautiousness surrounding tonight’s Fed meeting. A decline in oil prices following Monday’s sharp surge in the price of the commodity can also be attributed to the move in the common currency. Oil prices declined by around six percent after Saudi Arabia claimed that it would tap into its reserves to keep supply supported.

Inflation numbers out of the Eurozone this morning will, as always, be closely watched for any signs of a pick up. Aside from that, this week is relatively light on the ground in terms of European data, with much of the volatility in EUR/USD this week likely to be driven chiefly by tonight’s Fed meeting.