Bearish USD trend resumes after Fed policy update

USD: Has the Fed reached the end of their hiking cycle? 

The US dollar has continued to weaken during the Asian trading session following last night’s FOMC meeting. It has resulted in the dollar index falling to an intra-day low of 100.69 overnight as it moves further below levels that were in place prior to last night’s FOMC meeting when it was trading between 101.20 and 101.30. The broad-based US dollar sell off has been triggered by the dovish repricing of Fed policy expectations. The yield on the 2-year US Treasury bond has fallen by around 10bps since yesterday’s intra-day high to 4.82%. Market participants remain confident that the Fed has delivered the final rate hike in their tightening cycle overnight when the policy rate was raised by 0.25 point. The US rate market is currently pricing in around 10bps of hikes by the November FOMC meeting implying that a no further hikes is currently viewed as the more likely scenario going forward. The US rate market then expects the Fed to begin lowering rates by the March or May FOMC meetings of next year and to deliver around 125bps of cuts by the end of next year. Market participants’ dovish outlook for Fed policy was not significantly challenged by yesterday’s policy update.  

The comments from Fed Chair Powell in the accompanying press conference were viewed as market friendly as he made no serious effort to emphasize that the Fed will stick to their plans to deliver one final rate hike later this year. While he insisted that the September FOMC meeting is live, he characterized future policy decisions as data dependent. It supports our view that if inflation continues to slow in the coming months, we expect the Fed to signal a pause to their hiking cycle at either the Jackson Hole symposium towards the end of August or at the September FOMC meeting.  Chair Powell emphasized that the weaker June CPI report was just one print but said that the Fed would put more weight on evidence of slowing inflation if the next couple of CPI prints confirm the signal. Nevertheless, one further hike can’t be completely ruled out at this stage.  Before the next FOMC meeting in September, the Fed will have seen two more CPI prints, two more labour market reports, the Employment Cost Index for Q2 and activity data for Q3 which will give it a lot more insight into whether the US economy is on track for a softer landing where inflation falls back closer to target without the need for rates to continue moving higher that would increase the risk of harder landing. Fed Chair Powell sounded more optimistic over the prospect of a softer landing for the economy describing economic growth as “moderate” and the labour market as “cooling”. Overall, the developments do not alter our outlook for the US dollar to weaken further this year. The risk of a more hawkish Fed policy update last night has now passed leaving it vulnerable to further weakness.      

WEAK EURO-ZONE ECONOMIC DATA AHEAD OF ECB MEETING

Source: Bloomberg, Macrobond & MUFG GMR

EUR: Will the ECB commit to another hike later this year? 

Market attention will now turn to the ECB’s policy update this afternoon. The broad-based US dollar sell off overnight has helped to lift EUR/USD to an intra-day high of 1.1118 as it moves further above yesterday’s intra-day low of 1.1038. The euro had been weakening earlier this week heading into today’s ECB policy meeting to reflect the increasing risk of a less hawkish policy update today. It follows the recent run of weaker activity data, weak ECB bank lending survey and money supply report, and sharp drop in headline inflation for the euro-zone. It has even prompted normally hawkish ECB policymaker Klaas Knot to state that while a July hike is a necessity, “for anything beyond July it would at most be a possibility, but by no means a certainty”. He also believes the balance of risks for the ECB when setting policy is shifting so that the risks of perhaps doing too much needs to be paid more attention to. The comments support our view that the ECB will deliver another 25bps hike today but we do not expect the ECB to commit strongly to hiking rates again at the next policy meeting in September. The ECB will still leave the door open to one final hike later this year but it will emphasize that future policy decisions will be data dependent. One reason why the ECB could still deliver a final hike in September is that it has been focusing on core inflation and wage growth recently which are expected to remain uncomfortably strong over the summer. Without a strong commitment to another hike in September, the euro could sell off and drag EUR/USD back towards the 1.1000-level. The euro should weaken more though against other G10 currencies today.                     

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	13:15	Deposit Facility Rate	Jul	3.75%	3.50%	!!!
US	13:30	GDP (QoQ)	Q2	1.8%	2.0%	!!!
US	13:30	Initial Jobless Claims	--	235K	228K	!!!
EC	13:45	ECB Press Conference	--	--	--	!!!

Source: Bloomberg