Dollar Firm in the Wake of FOMC Decision

January 30, 2025
  • The Fed delivered the widely expected hold; Chair Powell gave a mixed performance; financial conditions continue to loosen; we get our first official read for Q4 GDP; BOC cut rates 25 bp to 3.0%, as expected; Brazil hiked rates 100 bp to 13.25%, as expected
  • ECB is widely expected to cut rates 25 bp; eurozone CPI data for January started rolling out; eurozone reported soft Q4 GDP data; SARB is expected to cut rates 25 bp to 7.5%
  • BOJ Deputy Governor Himino spoke; the Japanese government is forecasting significantly higher debt servicing costs in the coming years; January ANZ New Zealand business confidence softened

The dollar is firm in the wake of the FOMC decision. DXY is trading higher for the third straight day near 108.096 as markets digest the Fed’s hawkish hold (see below). USD/JPY is trading lower near 154.50 as markets shrug off rising borrowing costs for the government (see below). Sterling is trading lower near $1.2430 and the euro is trading lower near $1.04 ahead of the ECB decision as the eurozone economy stagnates (see below). CAD is outperforming as it shrugs off the BOC’s 25 bp rate cut. More and more tariff noise is likely in the coming days and weeks but we continue to look through that and focus on the underlying fundamental backdrop, which remains unchanged. Simply put, the strong U.S. fundamental story of strong growth, elevated inflation, and a more hawkish Fed continues to favor higher U.S. yields and a stronger dollar. Today’s Q4 GDP data should underscore the U.S. economic exceptionalism that favors the dollar.

AMERICAS

The Fed delivered the widely expected hold. The statement read hawkish, as it removed the reference to inflation making progress towards the 2% target. Instead, the Fed noted that inflation “remains somewhat elevated.” It also noted that unemployment has stabilized and the labor market remains “solid.” There were no dissents for the first time since the September 17-18 meeting. There were no updated Summary of Economic Projections, as the next one will be published in March.

Chair Powell gave a mixed performance. He started out hawkish. With regards to Fed policy, he stressed that “We do not need to be in a hurry to adjust our policy stance.” With regards to the change in the policy statement, Powell seemed to flip-flop as he said that the change in the sentence on inflation was not meant to send any signal and that the Fed “just chose” to shorten it. We find this incredibly hard to believe given that the Fed knows full well that the market is hanging on its every phrase and wording. Quite frankly, Powell should not have downplayed this change in wording because inflation is in fact no longer making any progress towards the 2% target.

When asked about the impact of the Trump administration on Fed policy, Powell was neutral. Specifically, he said “The committee is very much in the mode of waiting to see what policies are enacted. We need to let those policies be articulated before we can even begin to make a plausible assessment of what their implications for the economy will be.” Of note, the next Fed cut is still fully priced in for June and a second cut in Q1 2026 is still fully priced in. Both are slightly more dovish than previous pricing but it will all come down to the data. Next week brings a slew of key data that will help markets refine their Fed outlook.

Financial conditions continue to loosen. Conditions as measured by the Chicago Fed eased for the 13th straight week through last week and are the loosest since October 2021. We expect further loosening ahead and that should continue to support growth in 2025. This is just another reason why the Fed shouldn't be in any rush to cut rates again.

We get our first official read for Q4 GDP. Consensus sees growth of 2.6% SAAR vs. 3.1% in Q3, driven in large part by strong personal consumption of 3.2% SAAR expected vs. 3.7% in Q3. Core PCE is expected at 2.5% vs. 2.2% in Q3, reflecting the recent upward drift in inflation. Of note, the Atlanta Fed’s GDPNow model has a final estimate of Q4 growth at 2.3% SAAR. Its initial Q1 estimate will come tomorrow. Elsewhere, the New York Fed's Nowcast model has a final estimate of Q4 growth at 2.6% SAAR. Its Q1 growth estimate is at 3.0% SAAR and will be updated tomorrow, while its initial estimate for Q2 growth will come at the beginning of March.

Bank of Canada cut rates 25 bp to 3.0%, as expected. The bank also announced two changes to its monetary policy implementation framework. These tweaks are technical and have no material monetary policy implications. First, the BOC will end quantitative tightening (the process of letting bond holdings roll off the balance sheet as they mature without replacing them) and will begin purchasing assets as part of normal balance sheet management in early March. Second, the BOC announced that the deposit rate will be set at a spread of 5 bp below the policy rate. The aim is to mitigate some of the upward pressure that has been seen on the overnight rate relative to the policy rate in recent months.

Most importantly, the BOC signaled it may pause easing but cautioned that U.S. trade policy is a major source of uncertainty for Canada. The bank stressed that “the cumulative reduction in the policy rate since last June is substantial.” Updated macro forecasts show inflation remaining close to the 2% target over the horizon and also show slightly weaker GDP growth in 2025 and 2026. Markets now expect the BOC to deliver another 75 bp of easing over the next 12 months that would see the policy rate bottom near 2.25% vs. 2.50% prior to the decision. This would be at the lower end of the BOC’s nominal neutral interest rate estimate of 2.25-3.25%.

Brazil COPOM hiked rates 100 bp to 13.25%, as expected. It also signaled a hike of the same magnitude at the next meeting in March due to rising inflation expectations and a resilient labor market and economy. However, it added that “Beyond the next meeting, the Committee reinforces that the total magnitude of the tightening cycle will be determined by the firm commitment of reaching the inflation target and will depend on the inflation dynamics.” The market is now pricing in another 400 bp of tightening over the next 12 months that would see the policy rate peak near 17.25% vs. 16.25% before the decision.

EUROPE/MIDDLE EAST/AFRICA

European Central Bank is widely expected to cut rates 25 bp. We expect the ECB to stick to its data-dependent guidance by reiterating it “is not pre-committing to a particular rate path.” President Lagarde’s post-meeting conference may offer more near-term policy guidance. Watch out to see if Lagarde re-emphasizes the need for a “very cautious” easing cycle and/or acknowledge if there were once again some discussions around a proposal for a 50 bp cut. There are no new macroeconomic projections due at this meeting as the next updates will be published in March. The soggy growth outlook leaves plenty of room for the ECB to bring down the policy rate towards the middle of its neutral range, estimated at around 1.50-3.00%.

Eurozone CPI data for January started rolling out. Spain kicked things off today. Its EU Harmonised inflation came in a tick higher than expected at 2.9% y/y vs. 2.8% in December. Spain is one of the only eurozone countries to report core inflation and it came in a tick lower than expected at 2.4% y/y vs. 2.6% in December. France and Germany report tomorrow. France’s EU Harmonised inflation is expected to pick up a tick to 1.9% y/y, while Germany’s is expected to remain steady at 2.8% y/y. Italy and the eurozone report next Monday. Eurozone headline is expected to pick up a tick to 2.5% y/y while core is expected to fall a tick to 2.6% y/y.

Eurozone reported soft Q4 GDP data. Growth came in a tick lower than expected and was flat q/q vs. 0.4% in Q3. France contracted -0.1% q/q vs. 0.4% in Q3, Germany contracted -0.2% q/q vs. 0.1% in Q3, and Italy was flat q/q vs. flat in Q3. All three were a tick lower than expected. Spain was the lone bright spot as it reported stronger than expected growth yesterday of 0.8% q/q vs. 0.8% in Q3. More importantly, the GDP data underscore the U.S. economic exceptionalism that is likely to continue throughout 2025 and perhaps beyond.

South African Reserve Bank is expected to cut rates 25 bp to 7.5%. At the last meeting November 21, the South African Reserve Bank cut rates 25 bp to 7.75% and Governor Kganyago said, “As a central bank in a small, open economy, caution is what’s going to be at play here.” Its model also adjusted the expected rate path high, with the end-2025 policy rate seen at 7.40% vs. 7.17% previously, end-2026 at 7.27% vs. 7.09% previously, and end-2027 at 7.28%. The swaps market sees the policy rate bottoming at 7.25% over the next 12 months.

ASIA

Bank of Japan Deputy Governor Himino spoke. Himino reiterated the bank’s guidance that more hikes are in the pipeline if its economic and price outlooks are realized. Markets continues to see the BOJ policy rate to peak around 1.00% over the next two years. This seems about right as the BOJ expects inflation to stabilize around its 2% target in 2026. Bottom line: the BOJ’s shallow policy normalization cycle will be an ongoing headwind for JPY.

The Japanese government is forecasting significantly higher debt servicing costs in the coming years. In setting the budget for FY25, the Finance Ministry assumes the so-called accumulated interest rate at 2.0%, rising to 2.2% in FY26, 2.4% in FY27, and 2.5% in FY27. Those assumptions led the Ministry to estimate annual debt servicing costs to rise to around $230 bln over those next four fiscal years under the more optimistic 3% nominal growth scenario. Therein lies the unwanted consequences of normalizing monetary policy, as Japan has been able to run huge budget deficits at very little cost during a prolonged period of low rates. That is no longer the case, but the good news is that most of the JFBs outstanding are held domestically, with about half held by the BOJ alone.

January ANZ New Zealand business confidence softened. Business confidence dipped nearly 8 points to 54.4 after falling 3 points to 62.3 in December, while the expected own activity fell nearly 5 points to 45.8 that more than reversed the 2 point increase to 50.3 in December. Reported past activity, which has the best correlation to GDP, improved slightly to 0.2 vs. 0 in December suggesting a modest recovery in economic activity is underway. In line with RBNZ guidance, markets continue to imply another 50 bp rate cut to 3.75% in February and the policy rate to bottom around 3.0% over the next 12 months. RBNZ/Fed policy divergence remains a drag for NZD/USD. January ANZ consumer confidence index will be reported tomorrow.

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