Next week is the Federal Reserve’s monetary policy announcement and despite widespread expectations for the Fed’s second rate cut this year USD/JPY is trading strongly ahead of the rate decision. The pair ended the week up for the 7th out of 8 trading days. The latest economic reports beat expectations with retail sales rising 0.4% in August, which was double expectations. Consumer sentiment also improved with the University of Michigan Consumer Sentiment Index rising to 92 from 90.8.
According to Fed fund futures, the market completely discounted a quarter point rate cut and sees a 70% chance of a second move before the end of the year. Interestingly enough, these odds shifted lower over the past week because prior to that the market was pricing in a 100% chance of two rate cuts before the end of the year. Part of this has to do with stronger inflation and consumer spending numbers but some economists feel that by easing aggressively, the European Central Bank reduces the pressure on the Fed to do the same, especially if they effectively avoid a deep prolonged recession. Whether that’s true remains to be seen but in the immediate future, how the dollar trades for the days and weeks ahead will be determined by the tone of Fed Chairman Powell’s press conference.
US dollar bears could be setting up for disappointment because everything we heard from Federal Reserve officials suggests that they are reluctant to ease. Earlier this month, rate-cut expectations soared when Fed Chairman Powell said there are significant risks to the economic outlook and they would act appropriately to sustain expansion. However in that speech he also described the economic outlook as favorable, said the economy continues to perform well and the labor market is strong. A quarter-point cut will be coming because the Fed is “conducting policy in a way to address risks,” according to Powell but he could repeat the mantra that the economy is in a “good place.” Over the past few weeks, we’ve highlighted the long list of US policymakers who casted doubt on the need for easing and if the Fed remains optimistic, the dollar will rise. This includes FOMC voter Rosengren who said “no immediate Fed action is needed if data stays on track.” FOMC voter Williams also feels that the baseline for the economy is continuing strong growth and he won’t pre-judge the outcome of the September meeting. Since July, consumer spending slowed but inflation is steady and service-sector activity accelerated.
Come Wednesday, if the FOMC statement or Powell’s press conference oozes of optimism, the US dollar will rally even if the Fed lowers interest rates. If the decision to cut isn’t unanimous and 2 or more members vote to keep rates steady, we could see USD/JPY make a run for 110.
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