(Kitco News) – The Fed’s 50 basis point rate cut means it’s looking to move rates to neutral quickly in order to avoid a recession, while its impact on the dollar will likely influence the U.S. election, according to the latest analysis from ING.
“The lack of pushback on market pricing from the Fed in sourced media articles suggested it was inclined to go boldly and in the end there was only one dissenter – Governor Michelle Bowman, who voted for a 25bp cut,” wrote Chief International Economist James Knightley, FX Strategist Francesco Pesole, and Padhraic Garvey, Regional Head of Research for the Americas. “Being ‘strongly committed’ to supporting maximum employment and returning inflation to target continues to be the theme, but it is clear where the priorities lie; get policy back to a more neutral setting to avert the risk of recession given growing comfort that inflation is on the path to 2%.”
They said many economists believed that “the majority of Fed officials would be reluctant to take such bold action in an environment where the economy is growing at a 2.5-3% rate, equities are at an all-time high, inflation is above target and unemployment is low at just 4.2%,” and that the absence of clear financial system stress “argued for a more cautious 25bp cut.”
“A major catalyst for the move is likely to have been the narrative from the recent Federal Reserve Beige Book,” they noted. “This anecdotal survey on the state of the economy suggested that only three of the 12 Federal Reserve Bank districts reported growth over the previous eight weeks versus seven at the time of the previous report from July. With 75% of the Fed banks reporting flat or contracting activity, corroborated by weakness in ISM and NFIB business surveys, the Fed has taken the view that it needs to move policy from ‘restrictive’ territory towards ‘neutral’ quickly.”
“Our forecasts are broadly in line with what the Fed is indicating – get rates down to 3.5% or a bit below by next summer on the basis that prompt action from the Fed allows the US economy to avoid recession just as it did in the mid-1990s under Alan Greenspan,” they said. “That view still holds, but we certainly acknowledge that the jobs market outlook is more concerning and the risks are indeed skewed to the Fed having to do more, more quickly.”
“Remember 3% is not stimulative territory, so if the growth story weakens more markedly, then we know the Fed will go lower,” they warned.
ING sees a steepening of the curve as the most meaningful follow-on move. “Market reaction to the 50bp has been a steeper curve, from the front end,” they wrote. “Inflation expectations are up a tad as measured through the 10yr inflation breakeven rate. Reaction in risk space is positive as spreads tighten. Impact reaction had market rates net lower right along the curve.”
In foreign exchange markets, ING expects to see an acceleration in the ongoing build-up of dollar shorts.
“The dollar fell after the surprise 50bp cut but rebounded following Powell’s comments that seemed to push back against multiple 50bp cuts,” the analysts noted. “That said, if we had thought a dovish 25bp cut wouldn’t have turned the tide for the underperforming USD, a 50bp move unlocks more downside potential. Our calculations on CFTC data show that aggregate USD positioning against reported G10 currencies (i.e. G9 minus SEK and NOK) moved into net-short territory at the end of August. Still, those net USD shorts amounted to around 6% of open interest, a rather small figure compared to the 24% net-long peak reached last April.”
They also see the cut’s impact on the dollar influencing the U.S. presidential election on November 5.
“If unwinding dollar longs has been the story of the past few months, a steady build-up in dollar shorts may be the narrative into the US election,” they said. “Unless jobs figures come in much stronger than expected, and force the Fed to a more cautious easing path, the dollar appears bound to stay soft into the US election.”
“In November, a Trump win could see a sharp dollar rebound, especially if markets have built large USD short positions,” they predicted. “Should Harris secure the presidency, we’d probably be looking at a further gradual USD weakening into 2025.”
