Fed to Chill, Riksbank and BOC to Trim

January 29, 2025
6 min read

Fed to Chill, Riksbank and BOC to Trim

  • Fed is expected to keep rates unchanged. US primed for a productivity boom.
  • The Riksbank and Bank of Canada are expected to cut rates 25bps to 2.25% and 3.00%, respectively.
  • Australia underlying inflation cools, paving the way for the RBA to start easing in February. AUD underperforms.

Check-out our fresh of the press quarterly report. We discuss tariffs, trade relations, rising debt, and evolving labor productivity.

USD is firm ahead of the FOMC’s decision (7:00pm London). The target range for the Fed funds rate is widely expected to be left unchanged at 4.25-4.50%. The risk is the FOMC’s decision is not unanimous after Fed Governor Christopher Waller went full dove ahead of the media blackout. According to Waller “3 or 4 rate cuts is possible in 2025 if the data cooperates.” In contrast, Fed funds futures and the FOMC median projection imply 2 rate cuts in 2025.

There is no Summary of Economic Projection. The next one is published in March. Meanwhile, Fed Chair Jay Powell’s post meeting press conference will be highly anticipated following US President Donald Trump’s jab at the Fed. Trump said that “with oil prices going down, I'll demand that interest rates drop immediately”. When asked if he believed Fed officials would listen to him, Trump responded, “Yeah.” We expect Powell to emphasize again that the FOMC can be “more cautious as we consider further adjustments to our policy rate.”

Indeed, the bar for additional Fed funds rate cuts is high as US inflation is stalling above 2% and economic activity remains solid. The Atlanta Fed GDPNow model estimates above trend Q4 growth at 3.2% SAAR up from 3.0% on January 17. The final GDPNow update is due later today. Bottom line: monetary policy divergence between the Fed and other major central banks continue to underpin USD strength.

Moreover, the sudden rise in China’s AI startup DeepSeek strengthens our core view that the US is primed for a total factor productivity growth spurt. This is USD bullish and can lead to a further melt-up in global equity markets. The AI model created by DeepSeek match or outperform leading American models at a fraction of the cost raising the likelihood the adoption of AI can disseminate more quickly throughout the economy. We discuss the US productivity boom theme in our latest quarterly report (see here).

USD/SEK retraced some of yesterday’s gains. The Riksbank is expected to cut rates 25bps to 2.25% (9:00am London). Markets imply over 90% probability of a cut. In December, the Riksbank indicated “the policy rate may be cut once again during the first half of 2025” while emphasizing it will “carefully evaluate the need for future interest rate adjustments.” Sweden inflation was cooler than anticipated in December, suggesting it is still too soon for the Riksbank to pause easing. The Riksbank projects the policy rate to bottom at 2.25% but markets price-in odds of a lower policy rate at 2.00% over the next 12 months. Fed/Riksbank policy trend favors a higher USD/SEK.

USD/CAD is trading in a tight range around 1.4400. The Bank of Canada (BOC) is expected to slash the policy rate 25bps to 3.00% following two consecutive 50bps rate reductions. The BOC’s updated Monetary Policy Report is also due today. Inflation is stabilizing around 2% and business sentiment remains subdued but has improved. BOC Governor Tiff Macklem effectively ruled-out additional jumbo cuts, pointing out that officials will consider further rate cuts but likely at a slower pace. Markets are price-in almost 75bps of total BOC easing over next 12 months that should see the policy rate bottom near 2.50%. USD/CAD has scope to overshoot to fresh cyclical highs supported by FED/BOC policy trend, risk of all-out trade war between Canada and the US, and the Trump administration’s focus to lower energy prices.

AUD is underperforming. Australia’s Q4 CPI was soft and all but locks-in an RBA rate cut at the next meeting February 18. Headline CPI matched consensus at 2.5% y/y vs. 2.8% in Q3, reflecting large falls in electricity (-25.2%) and Automotive fuel (-7.9%). The more policy-relevant trimmed mean CPI inflation undershot expectations eased to a three-year low at 3.2% y/y (consensus: 3.3%, RBA projection: 3.4%) vs. 3.6% in Q3. Markets moved to virtually fully price-in (vs. 80% yesterday) a 25bps RBA cut to 4.10% in February and a total of 85bps of easing over the next 12 months. RBA/Fed policy trend and sluggish Chinese economic activity can further weigh on AUD/USD.

NZD/USD is range-bound around 0.5670. RBNZ Chief Economist Conway stuck to bank’s dovish guidance. Conway noted that “easing domestic pricing intentions and the recent drop in inflation expectations help open the way for some further easing”, adding he anticipates “interest rates to ultimately settle around neutral”. The RBNZ estimates the long-term nominal neutral interest rate to lie between 2.5% and 3.5%. In line with RBNZ guidance, markets continue to imply another 50bps rate cut to 3.75% in February and the policy rate to bottom at 3.00% over the next 12 months. RBNZ/Fed policy trend remains drag for NZD/USD.

USD/JPY is directionless above 155.00. The minutes of the Bank of Japan (BOJ) December meeting are outdated following last week’s 25bps policy rate hike to 0.50%. In December, the BOJ left the policy rate unchanged at 0.25% and the minutes showed the board discussed how high to raise the policy rate in the future. One member cautioned the BOJ “would need to slow the pace of policy interest rate hikes” once the policy interest rate approached the neutral interest rate. BOJ staff estimates the nominal neutral rate to be in a range of 1.00% to 2.50%. Markets continues to imply 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 shallow policy normalization cycle is an ongoing headwind for JPY.

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