Sovereign International Weekly Market Report
Dollar on the backfoot as markets price in 50% chance of a jumbo cut
The first reduction in US interest rates since 2020 this week will be a seminal event for markets worldwide.
Highlights:
As traders increased the odds of a 50 bp cut throughout the trading week, the dollar fell sharply against most peers and risk assets worldwide rallied, bringing key stock market benchmarks close to fresh record highs. The week's winners were Latin American currencies, led by the Chilean, Colombian and Mexican pesos, and the Japanese yen, which has become extremely sensitive to US interest rates as of late.
This week markets will be squarely focused on the outcome of the September Federal Reserve meeting. Obviously, the final decision of whether to cut 25 or 50 bp will be critical, but either way traders will have plenty additional information to digest, like the dot plot, updated staff forecasts, and Chair Powell communication at the press conference. The week will be rounded up the following day by the Bank of England meeting, where the consensus is for no move in rates given sticky inflation and resilient demand in the UK.
USD
The inflation number in the US came out higher than expected, as the core subindex increased 0.28% on the month, its second consecutive increase. Our favourite inflation indicator, the three-month core running average, has stopped falling and is perking up, though it is still close to the Fed target.
However, markets chose to ignore the number, as well as further indications that there is little job destruction in the labor market, and relentlessly increased its pricing of a jumbo move by the Fed this week to as much as 60%. We think this is excessive, expect a 25 bp cut and consequently think there is room for a tactical strengthening of the US dollar this week.
EUR
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The ECB cut rates as expected last week but provided little guidance about the future path of cuts. However, it hinted that a move at the next October meeting was not likely. Rate markets moved in sympathy with US ones afterwards to price in a 1-in-3 chance of such an outcome, but we think that it is unlikely.
Dismal Eurozone industrial production numbers will weigh less on that decision than sticky inflation numbers and relatively generous recent wage agreements, as the problems of the German industrial sector are structural and have little to do with interest rates.
GBP
We expect a frantically active week in pound trading. The key August inflation release on Wednesday will be followed by the BoE rate decision the next day, too close in time for the former to meaningfully affect the latter in our view. Economists are almost certain the outcome of the meeting will be a hold, though markets are pricing in a 1-in-5 chance of what would be a surprise cut.
The expected temporary rebound in inflation and Bank of England holds at the relatively high rate of 5% should help sterling remain at the top of the rankings among major currencies so far in 2024.
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