Reuters report triggers a brief relief rally for the EUR

USD: Fed signals higher rates for longer & softer landing for US economy   

The US dollar has continued to strengthen during the Asian trading session following yesterday’s FOMC meeting resulting in the dollar index hitting an intra-day high of 105.69. The stronger US dollar has been encouraged by the adjustment higher in US yields overnight. The 2-year Us Treasury yield has jumped by around 12bps since just before yesterday’s FOMC meeting and hit an intra-day high overnight of 5.18% which is a new cyclical high after it broke above the high from July at 5.12%. The move higher in yields at the short-end of the US curve has also lifted the long end but to a lesser extent with the 10-year US Treasury yield having increased by around 10bps to a new cyclical high of 4.45%. The main trigger was the Fed’s decision to deliver a hawkish hold overnight. While the Fed left the policy rate unchanged, the updated guidance provided a stronger signal that the Fed plans to keep rates higher for longer. It has prompted the US rate market to scale back expectations for rate cuts from the Fed next year. The US rate market is now pricing in around 58bps of cuts by the end of next year. Almost 50bps of cuts have been taken out of the US curve so far this month which is helping to provide more support for the US dollar.

The higher for longer message from the Fed was outlined through the updated economic and policy rate projections. The updated dot plot revealed that FOMC participants still plan to deliver one final rate hike later this year. 12 out of 19 participants favour lifting the policy rate to 5.625% by the end of this year. It is similar to the prior projections back in June when 12 participants favoured lifting the policy rate to 5.625% or higher by the end of this year. The biggest change to the forecasts is that FOMC participants now plan to cut rates less in the coming years. The median projection for the Fed policy rate by the end of next year and end of 2025 have both been raised by 0.50 point to 5.1% and 3.9% respectively. The Fed also released projections for the 2026 for the first time that showed the policy rate falling closer to their neutral rate estimate of 2.5%. The projection for the end of 2026 was set at 2.9%.

The main reason why the Fed has signalled a higher for longer rate outlook is that it has become more confident in the outlook for a softer landing for the US economy. There were significant upward revisions to the GDP forecasts for this year and next to 2.1% and 1.5% respectively which implies a more moderate slowdown in growth in the year ahead. As a result, the Fed now believes that the unemployment rate will not rise much further form the current rate of 3.8% and further above the cyclical low of 3.4% set in January. The unemployment rate forecasts for this year and next were both revised lower by 0.4 point to 4.1%. With less slack expected to open up in the US labour market, the Fed does not expect inflation to continue undershooting their projections in the coming years. The core PCE forecast for this year was revised lower 0.2 point to 3.7%, but the core inflation forecasts for next year and 2025 were left largely unchanged at 2.6% and 2.3% (+0.1 point). Overall, the Fed’s updated guidance should reinforce the US dollar’s upward momentum in the near-term. There is a higher risk of one final hike in November or December although weaker economic activity and core inflation data in Q4 should deter the Fed from delivering on those plans. Similarly, we expect to see a bigger negative impact on the US economy in the year ahead from the lagged impact of aggressive tightening to date that will encourage the Fed to cut rates more than the planned 50bps by the end of 2024.

USD VS. SHORT-TERM YIELD SPREADS

Source: Bloomberg, Macrobond & MUFG Research calculations

GBP: Case for another  BoE hike has become less compelling

The focus will now turn to the BoE’s latest policy update today. In contrast to the Fed, the BoE is expected to deliver a less hawkish policy update, and that is already placing more downward pressure on cable which has fallen to an intra-day low overnight of 1.2305. There is little in the way of technical support now until closer to the 1.2000-level which leaves the pound vulnerable to further weakness after today’s MPC meeting. As we highlighted in yesterday’s FX Daily Snapshot report, it is now a much closer call as to whether the BoE will deliver a final rate hike today after the August CPI report revealed a significant undershoot for core and services inflation compared to the August QIR projections. It follows recent evidence of weaker activity data at the start of Q3 and more evidence of a weakening labour market that do not together make a compelling case to hike rates further today.

The UK rate market has adjusted accordingly to pare back BoE rate hike expectations ahead of today’s MPC meeting. The UK rate market is currently pricing in a round 14bps of hikes for today and a total 24bps of hikes by February. The developments support our short GBP/CAD trade recommendation (click here). Even if the BoE delivers one final hike today, any relief rally would likely prove short-lived as we expect the BoE’s updated guidance to signal that it is close to or at the end of their hiking cycle and they now favour leaving rates at higher levels for longer in order to bring inflation back to target.           

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
SZ	08:30	SNB Interest Rate Decision	Q3	2.00%	1.75%	!!!
SW	08:30	Riksbank Policy Rate		4.00%	3.75%	!!!
SZ	09:00	SNB Press Conference	--	--	--	!!!
NO	09:00	Interest Rate Decision	--	4.25%	4.00%	!!
UK	12:00	BoE Interest Rate Decision	Sep	5.50%	5.25%	!!!
US	13:30	Current Account	Q2	-221.0B	-219.3B	!!
US	13:30	Initial Jobless Claims	--	225K	220K	!!!
EC	15:00	ECB President Lagarde Speaks	--	--	--	!!

 

Source: Bloomberg