Dollar plummets as Powell opens the door wide to rate cuts
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27 August 2024
Chief Risk Officer at Ebury. Committed to mitigating FX risk through tailored strategies, detailed market insight, and FXFC forecasting for Bloomberg.
At the Jackson Hole, Wyoming, annual central bank conference, Fed chair Powell left no doubt that he considers to fight against inflation as good as won and that the central bank’s priority has now shifted to preventing a serious deterioration of the US labor market. Markets responded by sending risk assets soaring, increasing their bets on a 50 basis point cut at the September meeting, and fleeing the US dollar, which fell against every major currency worldwide. The only exceptions were Latin American ones, which continue to be weighed by increasing political jitters around Brazil and Mexico’s leftist governments.
With the Fed set to ease, perhaps faster than European central banks, the path of least resistance for the dollar may be down, particularly in view of its still expensive valuation. This week, the narrative will be tested by two key inflation reports on either side of the Atlantic. On Thursday, the Fed’s preferred inflation measure, the Personal Consumer Expenditures (PCE) report for July, is released on Thursday, followed the next day by the Eurozone’s flash inflation number for August.
GBP
The PMI indices of business activity for August provided further proof of the healthy state of the UK economy, with both the manufacturing and service sector posting numbers consistent with solid and even modestly accelerating growth. The Bank of England signalled continued cuts but it kept its cautious tone. We think this opens up a bit of a sweet spot for Sterling, as healthy growth is combined with a cautious central bank and what will likely be the highest rates of any G10 economy for at least the next few months.
EUR
ECB officials are taking a very cautious line when it comes to further rate cuts, which contrasts with the less guarded optimism we are seeing from Federal Reserve officials. The resulting compression in interest rate differentials is providing a strong tail wind to the Eurom which has broken out of its recent range against the dollar. There are hints that inflation pressure sin the Eurozone are proving stickier than in the US, and good news on the economic front (particularly, better than expected service PMI numbers) have removed some of the urgency fo monetary stimulus. The flash inflation report for August out this Friday is a particularly important piece of information, as markets try to figure out whether the ECB can afford to ease at a faster pace than just one 25 bp cut per quarter.
USD
The clear Federal Reserve pivot to worrying more about a potential labro market slowdown and (much) less about inflation is perhaps the ideal cocktail for asset prices, including stocks, credit, and commodities. The early August sell off in markets has been all but forgotten, investors are snapping up risk assets, and the US dollar is falling. We do not disagree with a general downward trend for the greenback, but do think that the four cuts before year end that are being priced in by markets are excessive, even after the downward revision in job creation last week. High frequency indicators like weekly jobless claims are still consistent with a healthy job creation and consumption growth, and this should nudge the Federal Reserve towards cutting rates cautiously.
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