Sovereign International Weekly Market Report
Federal Reserve goes big, but dollar hangs on
The Federal Reserve decided to surprise markets and go for a double rate cut last week.
Highlights:
While risk assets celebrated worldwide, the dollar took it in relative stride. It helped that the Fed's communications were less dovish than the move would have implied, suggesting the central bank is not particularly concerned yet with the state of the US economy. The week's losers were safe havens generally, and particularly the Japanese yen, punished by traders after another dovish Bank of Japan meeting. The outstanding major currency was, however, sterling, once again buoyed by a relatively hawkish central bank that left rates unchanged at the highest level among G10 countries.
With the major central bank meetings out of the way, we now go into a quieter week. The main point of focus for traders will be the PMIs of business activity for September, released in most major economic areas on Monday. This morning’s Eurozone numbers were a major disappointment, while the UK figures also missed their mark, although remained consistent with solid expansion in Britain’s economy. We will also pay close attention to the Personal Consumer Expenditures inflation report out of the US on Friday.
USD
The impact on the dollar of the Federal Reserve’s 50 basis point cut was muted by a less dovish messaging from the Fed′s communication, particularly the ‘dot plot’. The Fed expects to lower rates at a relatively gradual pace. Officials now see just two more 25 basis point rate cuts this year, with four additional ones seen in 2025. Indeed, its estimate of the neutral level of rates in the US is still much higher than what markets are pricing in.
Economic data continues to track at or slightly better than expectations, consistent with solid growth in the 2-3% range, and high frequency labour market indicators like jobless claims show no upward trend in layoffs. We expect the PCE inflation data to confirm the modest rebound in inflationary pressures seen in the earlier CPI report and think the US dollar may stabilise near current levels after a rough summer.
EUR
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The question of whether the ECB will follow up its September rate cut with another one in October remains unclear. We think that inflation stickiness means that a single cut per quarter is likely from now on. As the Draghi report on European competitiveness suggests, Eurozone stagnation does not seem to be related to interest rates, which would perhaps suggest no rush to cut.
This morning’s business activity PMI figures were a disappointment, however, with the composite index slumping to January lows and printing below the level of 50 denoting contraction. This has undoubtedly made an October cut more likely, and we wouldn’t be overly surprised to see this reflected in a more dovish tone of communications from ECB officials in the coming days.
GBP
The Bank of England held interest rates last week at what is now the highest level of all G10 countries, save for New Zealand. The vote was nearly unanimous, with just one member, Swati Dhingra, voting in favour of another cut. As we had anticipated, the rhetoric in the bank’s communications were reasonably hawkish, with the bank reiterating the risks to cutting rates too quickly and by too much. The MPC suggested, in particular, that it is paying close attention to still elevated services inflation, which continues to print comfortably above 5%.
We think that the pound will remain well supported by relatively high rates, attractive valuation and decent economic growth. As mentioned, this morning’s PMI figures missed estimates, but the composite index remains above the level of 50 and continues to easily outperform the equivalent data in the Euro Area.
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