The dollar managed to hold on rather well last week, considering that the only US data point of the last few weeks (the September CPI report) all but guaranteed cuts at the next two Federal Reserve meetings.
The Fed is universally expected to slash rates again on Wednesday, notwithstanding the government shutdown, as there is nothing in the delayed data that could have conceivably derailed an October cut. We expect Chair Powell to firmly hint at another rate reduction in December, in line with the FOMC’s latest dot plot. There is considerable uncertainty about its future course, however. US inflation remains significantly above target, and there is little to go on about the state of the economy given the federal shutdown.
The ECB October meeting follows a day later, but rates are expected to remain unchanged for the foreseeable future. All eyes will instead be on Thursday’s meeting between Trump and Chinese President Xi, with markets positioning for some good news following reports that a framework for a trade deal had been reached over the weekend. Whether this results in the signing of a deal or another tariff delay remains to be seen, but investors will just be pleased that the threat of exorbitantly high levies has been seemingly averted.
GBP
The September inflation report out of the UK provided welcome news for the Bank of England. Inflation undershot expectations and was unchanged from the previous month at 3.8%, while the core subindex actually receded slightly to 3.5%. This has revived the possibility of an MPC cut in December, with swap markets now seeing around a two-in-three chance of another rate reduction before the year is out.
We are not convinced, however. It still holds true that UK inflation remains much closer to 4% than 3%, and still almost double the Bank of England’s 2% target, with no concrete evidence as of yet that price pressures have indeed peaked. In the absence of a marked deterioration in activity data, we think that the MPC will probably err on the side of caution and stay put for now, which should be marginally positive for the pound. The real wildcard here is, of course, the Autumn Budget, as a tax-heavy, anti-growth fiscal policy could elicit a more dovish retort on the monetary policy side.
EUR
An unexpected pickup in the Eurozone PMIs of business activity provides important validation for our view that the ECB's rate-cutting cycle has come to an end. We expect this week's meeting to be a non-event, with President Lagarde set to signal little appetite for further easing. The improvement in the PMIs was particularly notable in the German services sector, perhaps an early sign that the fiscal stimulus package is starting to be felt. Activity in France, on the other hand, continues to contract, partly in response to the acute uncertainty created by the recent political malaise.
Both the PMIs and the ECB's hawkish stance should, we believe, provide some modest support for the euro into year end. News of a US-China trade deal should, at the margin, also be positive for the common currency, given the bloc’s relatively high exposure to the Chinese economy.
USD
Despite the ongoing federal government shutdown, which looks highly likely to oust the 2018/19 closure as the longest on record, we finally received some first tier economic data out of the US last week. The delayed September inflation report came in slightly lower than expected, with the headline number falling to 3% for the first time since January. This remains significantly above target, however, and has been for the past four years, with the Federal Reserve itself expecting inflation above 2% until 2028.
None of this seems likely to stop the Fed from lowering rates again on Wednesday, or at its subsequent meeting in December. Yet, the outlook for rates next year is shrouded in uncertainty, particularly given the near complete absence of reliable economic data amid the government shutdown. We still think that the path of least resistance for the dollar is lower in the medium-term, and a more accommodative Fed in 2026 would merely support this view.
Deep dives and expert insights:
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