I hope the Chairman of the Federal Reserve Bank of America Jay Powell doesn’t have a sweet tooth. If he does, he’s in trouble as it appears, he simply can’t stop at one. Much like a child set loose with a biscuit tin, he couldn’t resist just one more cut to interest rate levels. It was the third cut this year with markets so far at least not pricing another Fed cut at their next meeting in December.
Starting in July, the Chairman led the bank in delivering a 25-basis point interest rate cut. Creating a limited ripple in Foreign Exchange markets and in particular the US Dollar, the cheapening of the cost of money at this event was presented as a mid-cycle adjustment. Powell told markets that he and his predecessor Janet Yellen had overcooked the tightening cycle of US monetary policy. Yeah right! Given the Fed’s intervention within the Repo market (an important source of liquidity in the US banking system) for the first time since the Financial Crisis of 2008, and two subsequent interest rate cuts at consecutive meetings, markets are inevitably going to start to think something’s up. This instability and economic stress should not be good for the US Dollar and indeed US economic growth.
On top of that, with the Canadian central bank led by Stephen Poloz holding rates yesterday, the highest yielding G-10 currency this morning is no longer the US Dollar! That’s a huge deal! For a long time when the US 10-year bond was yielding well over 3%, traders would head to the US Dollar and hold it overnight/days/weeks just to pick up the interest whilst also hiding behind its safe haven status. Now, the same style of trade will inevitably involve the question of the Canadian Dollar as an alternative to pick up yield. CAD is already the best performing G-10 currency so far this year up around 4% versus the US Dollar. Now offering a higher yield than its North American neighbour, there’s strong dynamics at play that will drag the Loonie higher against the Greenback.
So, if the Dollar lost the top spot last night in the G-10 space, if they cut rates themselves emerging from an ongoing context of Repo market action, you’d expect some serious ramifications in the value of the Dollar, right? USDJPY, the golden compass of risk, would surely fly off its handles downwards as the US Dollar lost value and the Yen gained a bid from defensive demand?! Wrong!
During the actual event the market went the wrong way. Despite immediately offering less interest to holders of USD, the strong forward guidance that suggested that this cut is the last one before a hefty pause, initially led the Dollar higher as it forced residual bets of early 2020 cuts and a December rate cut out of the price. The adjusted USDJPY stabilised to trade almost exactly in line with its pre-announcement levels at 108.80. From this we can see that the FX market wants to see liquidity introduced to the US economy and perhaps with 0.75% less interest behind US deposits in the last four months. Markets are increasingly satisfied they’re getting it.
Discussion and Analysis by Charles Porter