- A set of inflation reports convinced markets that the Fed would cut rates by 25-bps.
- The Wall Street Journal and the Financial Times reported that the Fed might implement a 50-bps rate cut.
- The European Central Bank lowered interest rates by 25-bps.
Currency futures extended Friday’s rally on Monday as the dollar fell to an almost nine-month low due to increased Fed rate cut expectations. The outlook for rate cuts shifted suddenly, with market participants moving to price a higher chance of a 50-bps rate cut.
Earlier last week, a set of inflation reports convinced markets that the Fed would cut rates by 25-bps. Core consumer prices were higher than expected, and producer prices beat estimates. Consequently, the likelihood of a small rate cut increased. At the same time, labor market data showed a gradual decline, easing fears of a recession.
Fed rate cut bets (Source: Bloomberg)
Therefore, before Friday, most market participants expected a gradual pace of Fed rate cuts. However, a sudden shift occurred when the Wall Street Journal and the Financial Times reported that the Fed might implement a 50-bps rate cut.
Furthermore, retired Fed official Bill Dudley said there was a strong case for a massive cut. As a result, market pricing changed, and the likelihood of a super-sized rate cut rose above 50%. This increase led to a decline in the greenback, allowing other major peers to climb.
However, the surge in rate cut bets created more uncertainty about the Wednesday FOMC policy meeting. Whether the Fed implements a small or significant rate cut, the market has not fully priced it. Therefore, there might be more volatility, with the dollar rising in relief or collapsing further.
Before the policy meeting, investors will focus on retail sales data. A bigger-than-expected increase in sales could strengthen the dollar, bringing back bets for a smaller rate cut. On the other hand, if sales miss forecasts, the likelihood of a massive cut will increase.
The euro rallied on Friday, a day after the European Central Bank lowered interest rates by 25-bps. However, the policy meeting boosted the euro since there was no clear guidance or future rate cuts. This led to a decline in rate cut expectations.
Meanwhile, the yen surged after several Bank of Japan policymakers voiced their support for more rate hikes. The prospect of more rate hikes by the BoJ amid Fed rate cuts gave the yen further support.
