Fed Swings the Axe

• Fed delivered a very dovish rate cut. This bodes well for risk assets and is a drag for USD.

• Bank of England and Norges Bank are expected to keep rates on hold today. Risk is the Norges Bank engineers a dovish pivot.

• Australia August jobs data was mixed. New Zealand Q2 real GDP falls less than expected.

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The Fed delivered a very dovish rate cut. The funds rate was slashed 50bps to 4.75-5.00% and the new Dot plots implied more easing in the pipeline. The Dots indicate eight additional 25bps cuts through 2026 for a total of ten cuts this cycle vs. nine previously. Specifically, the Dots show an additional 50bps cut by year-end, 100bps cut in 2025 and 50bps cut in 2026 to a terminal rate of 2.875%.

Moreover, the FOMC vote split suggests the threshold for further easing is low. Only Fed Governor Michelle Bowman voted against the monetary policy action, preferring instead a 25bps rate reduction. This was the first dissent since June 2022 and the first Fed governor to dissent since 2005.

There was no dovish curve ball from Fed Chair Jay Powell’s press conference. Powell emphasized that the decision for an outsized 50bps cut was designed to keep the US economy “in a good place”. Powell added “we do not think we are behind [in cutting rates]…But you can take this as a sign of our commitment to not get behind.” Powell also stressed that no one should look at 50bps as the new pace and he doesn't see anything suggesting that the odds of a downturn are elevated.

The Summary of Economic Projections highlight the FOMC’s growing confidence at a soft-landing. 2024 real GDP growth was lowered one tick to 2.0% and unchanged at 2% thereafter consistent with moderate growth. The unemployment rate forecast was raised across the projection horizon but remains in the low 4s in line with good labor market conditions. Finally, PCE inflation rates were tweaked lower for 2024 and 2025 while still projected to return sustainably to 2% in 2026.

The initial market reaction to the Fed’s decision was mixed. USD had a kneejerk downside reaction before finishing the session slightly higher. US stocks and Treasuries rallied briefly but ultimately closed a lower. In our view, a more dovish Fed and a strong US economy should further improve financial market risk appetite and undermine USD against most major currencies.

Second-tier US economic data are released today: Q2 balance of payments (1:30pm London), Philadelphia Fed business outlook (1:30pm London), weekly jobless claims (1:30pm London), and August existing home sales (3:00pm London).

GBP is up ahead of today’s Bank of England (BOE) meeting (12:00pm London). The BOE is poised to keep the policy rate unchanged at 5.00%. A majority of MPC members will likely want to wait for the upcoming October 30 government budget and the next November BOE Monetary Policy report before resuming cutting rates. Interest rate futures imply a small 16% probability of a 25bps cut. Attention will be on the vote split and the target reduction in in the BOE’s stock of UK government bonds for the next 12 months.

The BOE’s decision to cut the policy rate in August was a close call, suggesting the bar for a back-to-back rate cut is high. The vote split was 5-4 with the 4 dissenters supporting the case for no policy change. Notably, Governor Andrew Bailey voted with the majority for a cut while Chief Economist Huw Pill preferred to maintain the rate at 5.25%. Jonathan Haskel was another MPC member who voted to keep rates on hold in August but he’s since been replaced by Alan Taylor.

The BOE is also expected to vote to reduce the stock of UK government bonds by £100bn over the next 12 months driven by £87bn worth of maturing gilts. The past 12 months reduction in the stock of gilts was also set at £100bn but was equally split between maturities and sales. Overall, the BOE estimates quantitative tightening to have had little impact on gilt yields, the real economy, and market functioning.

NOK faces downside risk on the crosses today. The Norges Bank is widely expected to leave the policy rate steady at 4.50% (9:00am London). The risk is the Norges Bank engineers a dovish pivot and opens the door for a rate cut by year-end. Norway inflation has been tracking below the bank’s forecasts the past few of months and the NOK import-weighted exchange rate (I-44) is higher than the Norges Bank assumed in June.

Watch-out for the Norges Bank’s new policy rate forecasts to gage the extent of the easing cycle. In June, the Norges Bank projected steady rates of 4.50% until Q4 2024 and a first full 25 bp cut in Q2 2025. The swaps market sees almost 150bps of cuts over the next twelve months.

AUD/USD is breaking higher on broad USD weakness. Australia’s mixed August jobs data supports the RBA’s case against near-term policy rate cuts. Employment rose more than expected (actual: 47.5k, consensus: 26k, prior: 48.9k) but all the job gains were in part-time. The unemployment rate remained steady at 4.2% on an unchanged participation rate of 67.1% and remains at the lower end of the RBA’s estimated full employment range of 4.0-5.75%. Nevertheless, we expect the RBA to join the global easing cycle later this year because Australia underlying economic activity is weak and points to lower inflation pressures. RBA cash rate futures continue to price-in high odds (around 70%) of a 25bps cut by December.

NZD/USD is firmer. New Zealand’s economy turned out to be less sluggish than anticipated in Q2. Real GDP shrank -0.2% q/q (consensus: -0.4%, RBNZ projection: -0.5%) after rising 0.1% q/q in Q1 (revised down from 0.2%). The primary industry group (agriculture, forestry, and fishing and mining) was the main drag to growth, while the goods producing industry group made a positive growth contribution and the services industry was flat. The shallower downturn in New Zealand economic activity lowers the likelihood for another 100bps of RBNZ policy rate cuts by year-end.

Three EM central banks hold policy-setting meetings today: Taiwan is expected to keep rates steady at 2.0% (around 9:00am London). Turkey is expected to keep rates steady at 50.00% (12:00pm London). South Africa is expected to cut rates 25bps to 8.00% (around 2:00pm London). See our full preview here.