FOMC PREVIEW

_{All price forecast and data in this article is sourced from Reuters}

Markets believe the Federal reserve will continue to leave their monetary policy unchanged at the meeting next week. The CME FedWatch tool currently shows a 93% chance of no change. Focus at the meeting on Wednesday will be on what to expect in September and whether Powell will give any clear hints of a possible rate cut. Money markets are fully pricing in a 25bps cut at the next meeting.  

The reasoning behind no cut at the meeting next week is the fact that the economy continues to show some resilience. It´s true that the labour market has shown signs of cooling, but not collapsing. The unemployment rate has ticked up to 4.1% in recent months but it still remains below its long-term average. For now, the rise in unemployment is being caused by labour supply growth outstripping demand. As long as employers hold on to their current work-force the labour market remains resilient and seems to be avoiding a recession. Similarly, consumer prices continue to grow, albeit at a more normalised rate. Every month since mid-2020 consumer prices have risen, suggesting that, whilst price pressures have cooled, US consumers continue to have spending power. This also pushes back on the notion of recession.

But, some analysts are concerned that the Federal Reserve may wait too long to cut rates. Clearly there is no urge in having to cut, but it may be wise to loosen monetary policy gradually, as this could avoid elevated rates having a negative impact on future growth. For months markets have hoped for rate cuts and none have been delivered, mostly because of runaway inflation. But it seems like we may now be on the cusp of loosening financial conditions, and it can’t come sooner for markets.

The recent pullback in the stock market and the undoing of the yield curve inversion are signs that market participants are primed and ready for cuts. The increased expectation of rate cuts brings down the yield on short-term bonds, meaning the 2-year yield is dropping versus the 10-year yield. 

Recent comments from FOMC members suggest the central bank is becoming more comfortable with the idea of cutting rates. San Francisco Fed President Mary Daly suggested, “We don’t want to get to a point where we start to see the labour market weaken substantially – to falter – because by then, it is actually often too late to bring it back”.

Thus, the FOMC meeting next week presents a negative risk for the dollar. That said, if the central bank does not offer dovish remarks there could be limited upside for the currency. USD/JPY will likely be a key pair to watch given the ongoing correction and the BoJ meeting earlier that same day, with a possibility of a 10 basis point rate hike, which could fuel the yen recovery further.

_{All price forecast and data in this article is sourced from Reuters}