Second thoughts
With last week’s all-important data providing what can only be described as a mixed picture of the US economy, markets appear to be having second thoughts over the Fed’s meeting this week. With a heavy focus on the labour market over the last few months, it seemed last week that fears of excessive labour market weakness had been offset enough to push the Fed towards 25 basis points worth of rate cut. In an otherwise quiet session yesterday, an alternative narrative played out. Overnight index swaps showed rate expectations shift around this week’s Fed decision.
The shift was in favour of a 50-basis point rate cut. Not all of that ground left to cover was made up. But it is fair to say that the market now prices closer to a half point versus quarter point cut. Because of the stability of emerging market FX and equity markets during this shift, we can confidently say that the narrative of a soft landing is still very much alive. Under this environment the Dollar will continue to face headwinds until either the illusion of an outsized cut or wider market stability collapses.
With the decision due late in the European session tomorrow, markets will continue to trade based upon position adjustments in this single case issue. USDJPY has been likely the most sensitive pair to US rate cut expectations. Yesterday saw the pair push lower once again as expectations built for a 50-basis point cut at the Fed. The pair now trades around the 2024 low. Despite some support at this level, there would be further to fall should the terminal rate in the US continue to drift lower.
Discussion and Analysis by Charles Porter
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