Markets Brace For Fed To Cut

WHERE WE STAND – Markets meandered along once again on Tuesday, with conviction still lacking as participants’ attention remained squarely on the FOMC decision due later today.

Consequently, the price action provides little worth writing home about for the most part, as Treasuries firmed a touch led by the front-end, and equities largely trod water. Mercifully, the FX complex was somewhat more interesting, as the greenback continued to roll-over against all DM peers, most notably the EUR which traded to its strongest since September 2021, almost certainly worrying Lagarde & Co over at the ECB. In truth, though, 1.20 is probably their ‘line in the sand’.

In any case, that dollar weakness didn’t have a particularly obvious catalyst behind it, besides perhaps participants seeking to further trim positions into the FOMC decision today. That strikes me as a little counter-intuitive, though, especially when risks from that Fed meet are actually skewed in a hawkish direction relative to market expectations. I guess I may be guilty of fitting a narrative to the price there, but oh well.

Certainly, you can’t blame that dollar decline on yesterday’s data, with August’s retail sales report comfortably topping consensus estimates with an 0.6% MoM rise at the headline level, and an 0.7% MoM increase in the control group metric. Once again, the old adage that one must ‘never bet against the US consumer’ rings true.

On the subject of economic data, we also had the latest UK jobs figures yesterday. I shan’t say the data was brilliant, as a 4.7% unemployment rate clearly isn’t, but at least some signs of stability may finally be starting to emerge. Regular pay growth also dipped below 5% YoY in the three months to July for the first time since mid-2022, though such a pace is clearly still incompatible with a sustainable return to the 2% inflation aim over the medium-term.

That said, the data remains a complete & utter mess. As if to prove this point, the UK has either never had more people employed since records began (per the Labour Force Survey), or has been shedding jobs for the last year (per the HMRC Payrolls metric). With that in mind, I find it tough not to feel just a little sorry for the poor folk at the BoE, and at HMT, who are literally ‘flying blind’ when it comes to policymaking right now. The ongoing statistical shambles is nothing short of a scandal, and there hasn’t been nearly enough outrage over the matter, nor progress from the folk in Newport in resolving long-standing data quality issues.

Rant over, and before a Fed preview below, I suppose I should reiterate my broad biases in the interest of good order.

I remain a USD bear, emboldened by yesterday’s rather chunky decline, though cognisant of the risks that we see a short-term rebound in the buck if (when?) Powell & Co fail to live up to dovish expectations later on. That would be a rally I’d sell into, however, as the erosion of Fed independence should see outflows from the buck continue, benefitting the EUR, and gold – which notched new ATHs yesterday – the most. That should also see the Treasury curve continue to steepen.

The opposite of that is true of my equity view, where I remain bullish, but also see downside risks over the FOMC today. Still, any dips are there as buying opportunities, amid solid earnings growth, resilient economic growth, calmer trade rhetoric, and a much easier monetary backdrop.

LOOK AHEAD – Right then, here we are, the September FOMC meeting is upon us.

A 25bp cut from Powell & Co will come as no surprise this evening, with money markets fully discounting the target range for the fed funds rate being lowered to 4.00% - 4.25%. That cut, though, is unlikely to come courtesy of a unanimous vote – new Governor Miran is almost certain to dissent for at least a 50bp cut, while Govs Bowman and Waller may also dissent in a dovish direction; meanwhile, St Louis Fed President Musalem and/or Kansas City Fed President Schmid, could dissent in the other direction, preferring to stand pat.

The accompanying policy statement will again stress the FOMC’s data-dependency, though will likely flag ‘additional reductions’ in rates, as opposed to just ‘adjustments’ in order to cement an easing bias. Meanwhile, the updated SEP is likely to leave expectations for growth, inflation, and unemployment broadly unchanged over the forecast horizon. Along with that, the new ‘dot plot’ will probably again point to a total of 50bp easing this year, and likely another 50bp in 2026. The bar for the 2025 ‘dot’ to move lower is a high one, needing eight members to pencil in a more dovish path, though a lower 2026 median requires just one participant to shift their ‘dot’ lower.

Chair Powell, however, is again likely to play down the importance of the ‘dot plot’ at the post-meeting press conference, stressing that it is not a concrete commitment to a particular policy path. Powell is also highly unlikely to pre-commit to the timing, or size, of further rate reductions, though will indicate that the direction of travel for rates is downwards, back towards neutral. Though such remarks would be relatively neutral, they nonetheless present a hawkish risk for markets, with the curve discounting 75bp of easing this year, and a terminal rate of 3% by the end of H1 26, a high dovish bar that it seems almost impossible for the Fed to reach.

Elsewhere, the Bank of Canada will deliver a 25bp cut of their own this afternoon, also in an attempt to support the domestic labour market, and amid continued downside risks from sizeable US tariffs. Closer to home, this morning brings our latest read on the UK inflationary backdrop, with headline CPI seen having held steady at 3.8% YoY last month, ahead of a likely peak at 4% in September.