Markets Tighten Up

September 17, 2024

Elias Haddad

Markets Tighten Up

USD and Treasury yields are consolidating near recent lows as investors position for tomorrow’s Fed funds rate cut. We see three rate cut scenarios.

US August retail sales is today’s highlight.

Canada’s August CPI print will help shape the magnitude of the BOC’s October rate cut decision.

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USD and Treasury yields are consolidating near recent lows as investors position for tomorrow’s Fed funds rate cut. The probability implied by Fed funds futures of a 50bps rate cut rose to 70% (highest since early August) while almost five 25bps rate cuts are priced-in by year-end. Notwithstanding the “Powell wild card” and the FOMC voting spit, the three most likely scenarios tomorrow include:

(i) Hawkish cut. 25bps and the Dot Plot still indicating 9 rate cuts between 2024 and 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.

(ii) Dovish cut. 50bps and the Dot Plot still indicating 9 rate cuts between 2024 and 2026, with most of the easing front-loaded between 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 easing cycle would remain more modest than implied by interest rate futures.

(iii) Very dovish cut. 50bps and the Dot Plot indicating 10 rate cuts between 2024 and 2026, with most of the easing front-loaded between 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, 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.

US August retail sales is today’s highlight (1:30pm London). Retail sales is forecast to fall -0.2% m/m after rising 1% in July driven by a decline light-vehicle sales. More importantly, the retail sales control group used for GDP calculations is projected to rise for a second consecutive month by 0.3% m/m. Overall, consumer spending is supported by positive real wage growth, healthy labor market and strong household balance sheet.

US August industrial production (2:15pm London), August business inventories (3:00pm London), and NAHB September housing market index (3:00pm London) are also due today. Homebuilder confidence is expected to stabilize after slipping in August for a fourth straight month to its lowest point of the year. Overall, residential investment is forecast to remain a drag to growth in Q3. This could lead the construction sector to accelerate job cuts and worsen the slowdown in the US labor market. However, it’s worth noting that total construction jobs account for 5.2% of total non-farm employment while residential construction jobs make up 1.2%.

EUR/USD is holding on to most of yesterday’s gains. Germany September ZEW survey is up next (10:00am London). Both expectations and current assessment are expected to fall to 17.0 and -80.0, respectively, indicative of a poor economic activity.

USD/JPY failed to sustain a break of 140.00. The outcome of the Fed meeting tomorrow will guide the next big move in JPY. Japanese Finance Minister Shunichi stuck to the usual script noting that rapid yen moves are undesirable.

CAD will be guided today by Canada’s August CPI print (1:30pm London). Headline inflation is expected to slow to a 41-month low at 2.1% y/y from 2.5% in July. Both core trim and median are expected to dip two ticks to 2.5% y/y and 2.2%, respectively, the lowest since March 2021. For reference, the Bank of Canada (BOC) projects Q3 core CPI (average of trim and median CPI) at 2.5% and Q3 headline CPI at 2.3%. Slower inflation will boost the case for a 50bps cut at the next October 23 BOC meeting and undermine CAD. Currently, the market sees 50% odds of such a cut.

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