Just 4 months ago the Fed hiked interest rates and saw more such moves for 2019. Fast forward to present and some on the markets start speculating that rates could be cut as soon as this week! Why would the Fed consider such move and how one could link it with the US dollar being close to multi-month highs? We investigate those issues in this analysis.
Summary:
- The FOMC meeting the key position in the rich US calendar
- The Fed can feel the pressure to cut at some point
- Outlook for USD will depend on US data
Markets see 65% chance of rate cut by December
Global markets were hit with slowdown concerns late last year but have recovered since, buoyed by trade talks and a conviction that the global economic growth would recover. So how does that justify rate cut expectations? The reality is that while the markets recovered, the economy didn’t. Yes, the US Q1 growth was at solid 3.2% but pumped by inventories and imports decline. Meanwhile business activity data remains soft. Is that enough to cut rates now even though the US labour market remains strong? The Fed is not free from the political pressure and we have already seen so far this year. The US presidential elections are in the autumn of 2020 and if the Fed wanted to bolster economy ahead of that date, the cut would need to occur sooner rather than later.
Markets see high odds for interest rate cut this year. Source: Bloomberg
Will US dollar converge with bond yields?
In the FX market rising odds for a rate cut usually act to a detriment of the currency. Meanwhile the USDIDX (US dollar index based CFD) is close to 22-month highs! Why is this the case? The first reason that is being cited is liquidity shortage in the US. The other is the fact that economic conditions outside of the US are even weaker. However, it’s hard to ignore a yawning bond yield spread that is apparent on major currency pairs like EURUSD or USDJPY. We can see that dovish expectations led US yields lower at a faster pace (not least because they were higher to begin with) yet the dollar did not follow. Will that happen after the FOMC meeting?
EURUSD declined over the past few months despite a stable 10-year bond spread. Source: Bloomberg, XTB Research
US data key for the FX outlook
There’s a broad expectation that the Fed will be dovish at the meeting. However, it might be too soon to cut rates or even announce such move, especially as some data (mostly labour market) remains solid. For the Fed it could be wise to observe economic reports a bit longer and it happens that we will have 3 such reports over the next few days: ISM manufacturing (Wednesday), NFP report and ISM non-manufacturing (Friday). Weakening conditions could increase expectations for interest rate cut in the US.
Technical situation on the USDIDX chart
USDIDX has been trading inside the broad channel in the upwards direction for many months now. While the market secured fresh 22-mo highs, it reversed with a double spin formation. The first key support can be seen at 96.50 and a lower bound of a broad consolidation can be seen at 94.80. Resistance is at the recent high, just above 98.
Recent highs have been rejected with a double spin formation. Source: xStation5
