Dollar Remains Soft as FOMC Meeting Begins

September 17, 2024

Win Thin

The two-day FOMC meeting begins today; we see three possible scenarios tomorrow; August retail sales today will be important; Canada highlight will be August CPI
Markets are still digesting last week’s ECB decision; Germany reported a weak September ZEW survey
Japan’s LDP leadership race will likely come down to three candidates; Thailand’s cabinet approved a modified cash handout plan

The dollar remains under pressure as the FOMC meeting begins. DXY is trading lower for the fourth straight day near 100.640 as the market ramps up expectations for a jumbo 50 bp cut tomorrow (see below). The yen rally has stalled out, with USD/JPY trading flat near 140.65 after trading at a new cycle low yesterday near 139.60. The euro is trading flat near $1.1135 despite weak ZEW survey (see below), while sterling is trading flat near $1.3215. We continue to believe that market expectations for aggressive Fed easing remain overdone (see below) and yet we cannot stand in the way of this fast-moving freight train. Until market pricing changes, the dollar will remain under pressure. While we acknowledge heightened risks of a dovish surprise from the Fed tomorrow, we believe it is unlikely that the Fed will validate market pricing for 250 bp of easing over the next 12 months (see below). If so, the dollar could get some traction.

AMERICAS

The two-day FOMC meeting begins today. Consensus expects a 25 bp cut. However, a handful of analysts look for a larger 50 bp cut, while the market is pricing in 70% odds of such a move, up from 10% last week right after the PPI data. We favor a 25 bp cut but acknowledge real risks of 50 bp. The vote for the monetary policy action will be worth monitoring. The last time there was a dissent at the FOMC was at the June 2022 meeting. It’s worth noting that the Timiraos article suggested Powell’s colleagues were surprised by his dovish tone at Jackson Hole.

The new Dot Plots will be very important. We will clearly see a dovish shift in the Dot Plots. However, we do not think the Fed will validate the current market pricing for 250 bp of easing over the next 12 months. Recall that the June Dots saw one cut in 2024 vs. three in March, four cuts in 2025 vs. three in March, and four cuts in 2026 vs. three in March. Both March and June showed nine 25 bp cuts in all through 2026. Our base case is that the 2026 and longer-term Dots will remain unchanged this time and so the big question is how front-loaded the Fed thinks it needs to be.

We see three possible scenarios tomorrow. 1) Hawkish: 25 bp and the Dot Plots still indicating nine 25 bp cuts through 2026 (same as the Fed’s March and June Dot Plots). In this scenario, a relief rally in USD would likely unfold. underpinned by an upward adjustment to US interest rate expectations; 2) Moderately dovish: 50 bp cut and the Dot Plots still indicating nine 25 bp cuts through 2026, with most of the easing front-loaded in 2024 and 2025. In this scenario, USD has a kneejerk downside reaction as a jumbo rate cut is not fully priced in, but USD downside is limited because the Fed signals its easing cycle will remain more modest than market pricing; and 3) Very dovish: 50 bp cut and the Dot Plot plots indicating ten 25 bp cuts through 2026, with most of the easing front-loaded in 2024 and 2025. In this scenario, USD would come under further broad-based downside pressure on narrowing bond yield spreads and improving financial market risk appetite.

We lean towards the first scenario because the US macro backdrop is in a good place. Economic growth remains robust and driven by strong consumption, the progress on inflation is encouraging, and a soft-landing in the labor market is underway. However, we acknowledge the risks are heavily skewed towards the dovish scenarios, as the Fed may want to insure against a more pronounced labor market slowdown.

The dollar tends to weaken on FOMC decision days. It has done so for six straight, 13 of the past 15, and 17 of the past 20. Think about that last one. This 20 meeting streak began with the March 2022 FOMC meeting, when the Fed first started its aggressive tightening cycle. The recent price action suggests the market is setting up for a very dovish message from the Fed tomorrow.

Meanwhile, August retail sales today will be important. Headline is expected at -0.2% m/m vs. 1.0% in July, while ex-autos is expected at 0.2% m/m vs. 0.4% in July. Expectations for a weak headline reading are driven by soft vehicle sales data already reported. The so-called control group used for GDP calculations is expected at 0.3% m/m, same as July. August business inventories and industrial production are also reported today.

In that regard, growth remains robust in Q3. The Atlanta Fed’s GDPNow model is tracking Q3 growth at 2.5% SAAR and will be updated today after the data. Elsewhere, the New York Fed’s Nowcast model is tracking Q3 growth at 2.6% SAAR and Q4 growth at 2.2% SAAR. Both estimates will be updated Friday.

Regional Fed surveys for September started rolling out. Empire manufacturing survey kicked things off yesterday and came in at 11.5 vs. -4.0 expected and -4.7 in August. This was the first positive reading since November. New York Fed services will be reported today and stood at 1.8 in August. Philly Fed manufacturing will be reported Thursday and is expected at -1.0 vs. -7.0 in August.

Housing market data will also be of interest. NAHB housing market index for September will be reported today and is expected to rise two points to 41 after slipping in August for the fourth straight month to its lowest point of the year. August building permits (1.1% m/m expected) and housing starts (6.2% m/m expected) will be reported tomorrow. August existing home sales will be reported Thursday and are expected at -1.3% m/m vs. 1.3% in July. While residential investment is forecast to remain a drag on growth in Q3, the drop in mortgages and the upcoming Fed rate cuts should give the housing sector a boost in Q3 and beyond.

Canada highlight will be August CPI. Headline is expected at 2.1% y/y vs. 2.5% in July, while both core median and core trim are expected to fall two ticks to 2.2% y/y and 2.5% y/y, respectively. If so, headline would be the lowest since February 2021 and basically back at the 2% target. For reference, the Bank of Canada (BOC) projects Q3 core inflation (average of trim and median CPI) at 2.5% and Q3 headline inflation at 2.3%. Slower inflation will boost the case for a jumbo 50 bp cut at the next October 23 BOC meeting. Currently, the market sees 50% odds of such a cut.

EUROPE/MIDDLE EAST/AFRICA

Markets are still digesting last week’s ECB decision. After the less dovish than expected message, unnamed officials said an October cut had not been ruled out. Odds of a cut then stand near 30% vs. 50% last week after the decision. We expect the battle between the hawks and the doves to remain in play. Today, Simkus said “It’s natural that the likelihood of October reduction is very small. It’s questionable if there’s a need for this. The euro-area economy is developing according to our forecasts and that’s been the story of the past two years.”

Germany reported a weak September ZEW survey. Expectations plunged to 3.6 vs. 17.0 expected and 19.2 in August, while current situation fell to -84.5 vs. -80.0 expected and -77.3 in August respectively. June retail sales came in Friday at -3.9% y/y, reflecting weakening consumer sentiment. For the eurozone as a whole, expectations fell to 9.3 vs. 17.9 in August. ZEW President Wambach noted that “The hope for a swift improvement in the economic situation is visibly fading. Although the falling economic expectations for the eurozone point to an overall rise in pessimism, the drop in expectations for Germany is significantly greater.” German GDP contracted in Q2 and we see growing risks of another contraction in Q3. This is not something the ECB foresaw in its forecasts.

ASIA

Japan’s LDP leadership race will likely come down to three candidates. Reports suggest that support amongst the LDP rank and file has coalesced around Sanae Takaichi, Shinjiro Koizumi, and Shigeru Ishiba, with the other six candidates struggling to attract significant support in a large field. The LDP leadership election will be held September 27 and will be decided by party membership, not the public. Based on LDP surveys, both Yomiuri and Nikkei see Ishiba and Takaichi going to a second round runoff. However, an Asahi survey suggests Ishiba and Koizumi will go to a runoff. Stay tuned, it’s going to be a close one.

Thailand’s cabinet approved a modified cash handout plan. The plan totals THB145.6 bln ($4.4 bln) and would give THB10,000 each to nearly 15 mln of the most vulnerable starting September 25. According to Finance Minister Pichai Chunhavajira, the beneficiaries include 12.4 mln state welfare cardholders as well as 2.15 mln with disabilities. Compare this with the original cash handout plan under former Prime Minister Srettha Thavisin that would have reached nearly 55 mln out of a nation of 71 mln and was widely regarded as unnecessary and inflationary.

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