The main event of this week, in central bank land at least, will be the Federal Reserve meeting later today. The two-day meeting concludes when the policy statement and fresh new Summary of Economic Projections will be released, followed by Chair Powell’s press conference.
Market Pricing and Expectations
A quarter point reduction in rates, the second consecutive cut in the current easing cycle, is fully priced in by markets with a half point cut now highly unlikely. There appears to be nothing in the most recent Fed
speeches to indicate a larger cut of 50 basis points which would normally only be seen during recessions. Much of the dovish pricing that existed in markets has recently been priced out. At the start of this month, markets were signalling about five more rate cuts by the end of 2020 but fed fund futures now have three cuts priced including this week’s forecast cut.
Expectations are for the Fed to continue to signal its intention to ‘act as appropriate to sustain the expansion’, even with the divergent views expressed by other Fed speakers and this means more rate cuts will only follow if the outlook deteriorates. Chair Powell is also likely to continue to describe the economy as being on solid foundations while steering clear of President Trump’s trade policies and criticisms.
Dissent, but not as strong as the ECB!
There will most likely be some dissenters in the FOMC ranks, with Esther George and Eric Rosengren who opposed the 25bp rate cut in July, again voting against more policy easing this week. This is especially due to the pick-up in inflationary pressures seen in the last print with both average hourly earnings and core CPI rising at their fastest rates since the global financial crisis. It is also possible that they could be joined by one or two other FOMC members.
On the dovish side, there is some speculation that James Bullard may vote for a 50bp rate cut, which would counter the dissenters above and alter the balance of the statement as well.
Press Conference Key
All the action is likely to take place around the growth and inflation forecasts and then the verbal guidance of Chair Powell and reasoning behind the decisions in the press conference. The focus here will be any material changes to the growth forecast revisions. Also, whether inflation remains on track to return to target within the projected horizon as the June projections for core PCE acutally remain in the ballpark of consensus expectations.
Market Impact
There is the potential for the Fed to disappoint which would weigh on EUR/USD. Indeed, during the previous FOMC meeting in July, the Fed cut by 'only' 25 basis points and failed to pre-commit to any further rate cuts. This saw a 50 pip fall in EUR/USD so it is quite feasible we see a similar reaction later today. If Chair Powell talks about a medium-term adjustment again, the recent move higher in bond yields could continue and the curve (2-year to 10-year) could start to flatten again.
In summary, we think like most Fed observers, that the FOMC will continue to characterize the additional accommodation as an 'insurance cut' and not the beginning of an easing cycle. The link between monetary policy and trade policy will be the key determinant to whether more policy easing is warranted. This means the recent hawkish re-pricing would then be reversed. However, there is still little evidence of the weakness from the manufacturing sector via trade uncertainty spilling over significantly into the other main parts of the economy.
One side note is the extreme tightness seen in US money markets over the last few days. Large tax and coupon payments, plus low bank reserves have caused a spike in overnight repo rates (up to 10%!) We tend to think technical moves like this are addressed elsewhere but if there is mention of any type of balance sheet expansion, then certainly the dollar would take a hit.
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