Two cuts down
The Federal Reserve cut the target Fed funds rate by 25-basis points again last night. This brings the benchmark range down to a 3.75-4% banding. This move had been widely expected, but that does not mean it did not have any market impact. As of market open today, the dollar continues to hold onto a residual bid from this event. The cause of that increase in Dollar demand comes from two key factors. First of all, the dissenting vote of Jeffrey Schmid who voted to keep rates on hold was not expected. This evidences at least some appetite amongst the Fed board to be cautious and adjust rates at a slower pace.
This pushed the dollar higher immediately after the publication of the decision. However, what likely allowed the dollar to continue to hold onto that bid were the remarks of Fed Chairman Jay Powell at the press conference. He noted overall that the outcome of the December Fed decision is far from a foregone conclusion. Up until last night’s decision, markets been confident that the Federal Reserve would deliver a further cut in December. Following last night’s press conference, there is no longer as greater conviction behind that call, with a hold in December now seen as significantly more likely. Moving into last night’s decision some 100-basis points of interest rate cut had been priced into the curve by the end of 2026. That now stands at least 15-basis points lower at circa 0.85%.
The risk holding the Fed back from cutting rates as much as the market had expected is persistently high inflation. Markets had believed that signs of weakness in the labour market given the Fed’s dual mandate would be sufficient to force their hand in adjusting rates lower. From the language of the chairman last night, that may not be the case. In addition to this, some interesting developments on the Fed’s QT programme show that the Federal Reserve will begin to acquire more treasuries. Due to a phasing out of their MBS activities, the Fed’s overall balance sheet will remain stable, and therefore this is not a QE event. However, the buying of treasuries will not go without market impact.
Discussion and Analysis by Charles Porter
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