FX Daily: Pieces falling into place for a September Fed rate cut

As James Knightley writes in his review of yesterday's July CPI release, the softer trend in inflation will be music to the ears of the Federal Reserve. Core inflation is running at a 1.6% three-month annualised rate – under the Fed's 2% target. Most of the components of this week's PPI and CPI releases point to an on-target 0.2% month-on-month release of the July core PCE inflation data on 30 August. We should now be expecting some dovish commentary coming through from the Fed and would look out for key speeches from someone like Christopher Waller. And of course, next week's Fed's Jackson Hole Economic Symposium presents the opportunity for Chair Jerome Powell to very much welcome recent inflation trends.

Now that inflation is under control, attention squarely shifts to the speed of Fed rate cuts. One example here was a very dovish cut by the Reserve Bank of New Zealand yesterday, where the central bank sounded in a hurry to get the 5.50% policy rate down to the neutral 3.00% rate. It only cut by 25bp yesterday but had discussed a 50bp cut. True, New Zealand's economy (small, open) is very different from the US (large, closed), but the RBNZ does show an example that central banks can shift narratives pretty quickly.

Activity data will now determine whether the Fed cuts by 25bp or 50bp in September. The August jobs data on 6 September will have a major say here. In advance of that, today sees retail sales for July. The bounce back in auto sales is expected to support the headline number, but the market will focus on the retail sales control group. This is expected to rise 0.1% MoM after stellar 0.9% gains in June. The consensus is 0.1% MoM and any MoM decline here (-0.1%, -0.2% are possible) could weigh on the short end of the US rates curve and the dollar. The market will also be paying close attention to the weekly initial claims to see whether any of the recent layoff announcements are finally lifting the claimant count.

With cross-market volatility falling and the Fed about to embark on an easing cycle, the dollar is behaving itself and turning gently lower. Our bias would be for DXY to retest the 102.16 low from early this month, below which the move could pick up a little momentum. 

Chris Turner

The eurozone economy does not have a lot to shout about at the moment. And a rebound in the Chinese economy remains elusive. Yet the prospect of the US economy and interest rates converging on the lower levels in the rest of the world is proving supportive for EUR/USD. This can be seen in the FX options market, where in the one-month tenor, the price of a euro call option over a euro put option has turned positive for the first time since February 2022. In our recent FX talking publication, we felt EUR/USD had the legs to move to 1.12. We would like to keep this bias for the time being even though the prospect of European fiscal consolidation and potentially wider sovereign spreads may reappear in September.

We see EUR/USD support at 1.0985/1000 and any softer US activity data could drag it up towards 1.11. While it is tempting to say that EUR/USD will remain in a 1.05-1.11 range for evermore, we would caution that realised EUR/USD volatility has been exceptionally low over the last couple of years and that range breakouts should be respected.

Chris Turner

Norway’s central bank announces monetary policy at 10:00am CET, and we expect a hold in line with consensus and market pricing. Since no new economic projections are published, the focus will be on whether policymakers will tweak their policy statement on the back of the global dovish repricing in rate expectations.

As discussed in our preview, NOK is around 3% weaker on a trade-weighted basis compared to the Norges Bank projections for this quarter, and Governor Ida Wolden Bache stressed at the last policy meeting that “if the krone depreciates, wage and price inflation could remain elevated for longer. In that case, there may be a need to raise the policy rate”. It is true that inflation slowed more than expected in Norway in the past couple of months, but Norges Bank does not have the same growth and jobs market concerns of the Fed and the Riksbank (you can find our preview for the next policy meeting in Sweden here).

Accordingly, we think Norges Bank will retain a hawkish stance at this meeting, stressing the risks of a weak krone. That should keep rate cut expectations for year-end capped at the current 20-25bp for now, and can smooth the path for further recovery in NOK. We target a return to 11.50 in EUR/NOK in the coming weeks thanks to NOK’s high beta to the Fed rate-cutting cycle and improvement in risk sentiment.

Francesco Pesole

As Rob Carnell writes overnight, the strong Australian July employment data may prove something of a headache for the Reserve Bank of Australia. Strong gains in full-time employment look likely to delay the RBA from tumbling into full easing mood as already seen in New Zealand and will probably be seen by the Fed in September.

This should imply that the Australian dollar does well on the crosses. The early August tumble in AUD/NZD suggests that investors had liked this cross to trade higher, but yen-triggered deleveraging forced the unwind. We can now see this cross retesting the 1.1150 highs from mid-July. Equally, if the Fed is to cut in September and the US yield curve to steepen further, EUR/AUD should come lower. But it may well be that macro weakness in China is holding the AUD back here. Overall, Francesco Pesole has a one-month target at 0.68 for AUD/USD.

Chris Turner