Fed D-Day

December 18, 2024
6 min read

Fed D-Day  

  • The Fed is expected to cut the funds rate 25bps. The bar for a hawkish surprise is high.
  • Sticky UK services inflation will keep the BOE on alert.
  • Bank of Thailand and Bank Indonesia stand pat. Chile’s central bank delivered a hawkish cut. Hungary’s central bank delivered a hawkish hold.

USD is firmer within its multi-day range. Treasury yields and the S&P500 continue to consolidate near recent highs. Financial markets will take their cue today from the FOMC rate decision/Summary of Economic Projections (7:00pm London) and Fed Chair Jay Powell’s press conference (7:30pm London).

The FOMC is expected to cut the funds rate 25bps to a target range of 4.25-4.50%. We expect the FOMC to prepare the market for a pause which can offer USD and Treasury yields additional support. The US economy is robust, progress on inflation is stalling above 2%, and financial conditions are very loose.

We anticipate upward revisions to the FOMC policy path, real GDP growth and PCE inflation projections. We also see the risk that at least one FOMC member (Fed Governor Michelle Bowman) dissents in favor of keeping rates on hold while Fed Chair Jay Powell could lean against an aggressive easing cycle.

However, the bar for a hawkish surprise is high because US interest rate futures already price-in less easing than the expected upward revision to the FOMC policy path. Fed funds futures price-in 50bps of cuts in 2025 while consensus expects the 2025 median Dots to be raised to 3.625% vs. 3.375%, implying 75bps of cuts next year. The 2026 and 2027 median Dots are both expected at 3.125% vs. 2.875%, previously. The longer run median Dots is expected to rise to 3.00% from 2.875%. In contrast, the swaps market price-in the funds rate to bottom around 3.75% over the next three years.

The US November retail sales print was indicative of solid consumer spending activity. The retail sales control group - used for GDP calculations – recovered in line with consensus by 0.4% m/m after contracting -0.1% in October. Overall, the U.S. economy is still tracking well above long-run annual trend growth of 1.8%. The Atlanta Fed GDPNow model estimates Q4 growth at 3.1% SAAR down from 3.3% on December 9. The next GDPNow update is due today after the November housing starts data.

GBP is trading on the defensive. UK November inflation largely matched consensus. Headline CPI rose 2.6% y/y (consensus: 2.6%) vs. 2.3% in October as the Ofgen price reductions in 2023 Q3 and Q4 dropped out of the annual comparison. Core CPI increased to 3.6% y/y (consensus: 3.5%) vs. 3.3% in October, and services CPI was unchanged at 5.0% y/y (consensus: 5.1%, BOE projection: 4.9%). Stubbornly high services inflation argues for a cautious Bank of England easing cycle. Bottom line: monetary policy trend between the ECB and BOE still favors a lower EUR/GBP.

USD/JPY uptrend is intact. Japan’s cumulative merchandise trade deficit narrowed to -¥5.85tn (or -1% of GDP) vs. -¥5.91 in October suggesting the drag on the economy from net trade should ease. Meanwhile, the cumulative trade surplus with the US narrowed slightly in November but remains historically high at ¥8.7tn (1.4% of GDP), placing Japan’s economy at a disadvantage in case trade tensions with the US rise.

AUD/USD plunged to a fresh cyclical low near 0.6310 on lower iron ore prices. Australia 10-year government bond yields drifted lower and ignored the country’s mid-year fiscal review. The Australian government raised its budget deficit projection for the 2025/26 fiscal year through to 2027/28. Nevertheless, the structural budget balance estimate - which adjusts for temporary factors - are broadly in line with estimates in the 2024–25 Budget and should not complicate the RBA’s job. RBA cash rate futures still imply about 60% probability of a 25bps cut in February.

NZD/USD dropped to more than a two-year low at around 0.5730. The broad-based decline in AUD dragged NZD lower. New Zealand’s annual current account deficit narrowed to -6.4% of GDP in Q3 from -6.6% in Q2. The current account deficit remains large by historical standards, suggesting NZD needs to keep trading at a deep discount to fundamental equilibrium to attract foreign investments and finance this deficit. We estimate long-term fundamental equilibrium for NZD/USD at 0.6610.

USD/CAD is making new highs above 1.4300. Canada’s November CPI report was mixed. Headline inflation unexpectedly slowed to 1.9% y/y (consensus: 2.0%) vs. 2.0% in October. However, core inflation (average of trim and median CPI) was sticker at 2.65% y/y (consensus: 2.5%) vs. 2.65% in October. Bottom line: the Bank of Canada (BOC) has room to ease further but likely at a slower pace because core inflation is tracking above the BOC’s Q4 projection of 2.3%. Monetary policy trend between the Fed and BOC still favors a higher USD/CAD.

Bank of Thailand delivered a neutral hold. The bank voted unanimously to keep rates steady at 2.25% and stressed that medium term inflation forecast remains within the target. The swaps market is pricing in 50 bp of easing over the next 12 months that would see the policy rate bottom near 1.75%.

Bank Indonesia left the policy rate at 6.0%, in line with consensus. Governor Warjiyo said “the decision is aimed at supporting the country's economic growth, maintaining the rupiah's stability and keeping inflation within the 1.5% to 3.5% target range in 2024 and next year.”

Chile central bank delivered a hawkish cut. The bank unanimously voted to cut the policy rate 25bps to 5.00%. The bank also signaled it may pause easing noting that “the balance of risks for inflation is biased to the upside in the short term, which highlights the need to be cautious.” The market price-in 50bps of cuts over the next 12 months.

National Bank of Hungary (NBH) delivered a hawkish hold. As was widely expected, the bank kept the policy rate steady at 6.50%. Only one MPC member recommended a rate cut suggesting the bar for NBH to resume easing is high. Indeed, NBH emphasized that “geopolitical tensions, volatile financial market developments and the risks to the outlook for inflation warrant further pause in cutting interest rates.” The market implies just one 25bps cut over the next 12 months.

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