Fed front and centre this week

The main currency pairs were largely unchanged on Friday and may continue to tread water ahead of this week’s Fed interest rate announcement on Wednesday. After a nine-month hiatus the Fed is expected to resume lowering rates with a 25bps cut to 4.0%-4.25%, but of more interest will be what its so-called ‘dot plot’ indicates about further rate cuts beyond this week. The previous one – in June – signalled a 50bps reduction in rates to 3.75%-4% by the end of this year and another 25bps cut to 3.5%-3.75% by the end of next year. The updated ‘dot plot’ may show rates lower than 3.5%-3.75% by end-2026, though maybe not quite as low as circa 3% as currently priced in by the market. The Fed’s post-meeting commentary may also be relatively cautious, as it highlights the difficult balancing act of addressing upside risks to inflation on the one hand but downside risks to employment on the other. The euro and sterling kick off this week trading at $1.1735 and $1.13550 against the dollar respectively, with EURGBP at around £0.8650.

The market has been more or less pricing in a Fed rate cut at this week’s meeting since the much weaker than expected US jobs report for July (including downward revisions  to May-June) published at the beginning of August. This has contributed to a sharp fall in US government bond yields in the intervening period, with 2-and 10-year yields about 40bps and 30bps lower respectively, in contrast to a slight rise in equivalent German and UK yields. US yields edged up on Friday (by 2-4bps across the curve), reversing some of Thursday’s post-CPI inflation data decline, as did German and UK yields (+4-6bps).

Consumer confidence in the US slipped for a second consecutive month in September, according to the University of Michigan’s preliminary reading, and remains well below its level at the end of last year. A renewed increase in consumers’ inflation expectations (at both short- and medium-term horizons) has weighed on sentiment over the past couple of months, which in turn may weigh on consumer spending.

In comments on Friday, ECB member Kocher said interest rates can remain on hold for now provided there are no “shocks” in the economic data, adding that the next move in rates could go in either direction. The latter is consistent with the ECB’s current monetary policy stance i.e. the deposit rate in neutral territory and upside and downside risks to both inflation and growth broadly balanced.

The Fed meeting is obviously the main focus for markets for the coming week. There’s a batch of US economic data due ahead of Wednesday’s rate announcement though, with retail sales, industrial production and import prices all published on Tuesday. Some important data are scheduled in the UK, which could have a bearing on market expectations for Bank of England interest rates, with the labour market report for May-July on Tuesday and CPI inflation data for August on Wednesday.