Market Dynamics Reflect Growing Expectations for Fed Rate Cuts Amid Economic Uncertainty
Investors are increasingly positioning for anticipated rate cuts by the Federal Reserve, following Chair Powell’s dovish remarks at the Jackson Hole conference. Swap prices suggest a consensus of around 100 basis points in rate cuts across the Fed’s three remaining decisions this year, implying at least one significant 50 basis point reduction. However, recent signs of resilience in U.S. economic growth, highlighted by a sharp rebound in durable goods orders, have raised doubts about the extent of the upcoming easing cycle. With the high threshold for further dovish adjustments, a major decline in the USD may require markets to fully anticipate a U.S. recession. In this context, the absence of major U.S. economic data this week could benefit the dollar, though initial jobless claims might draw increased attention as the labor market has become a key indicator for gauging the Fed’s potential easing path.
The prevailing Fed narrative is broadly negative for the dollar, driven by expectations of aggressive policy easing. This sentiment shift is evident in recent positioning data, where speculators have turned bullish on the euro, pound, and yen against the dollar for the first time since early 2021.
Sterling Resilient Amid Global Risk Sentiment Despite Limited UK Economic Data
With no major UK economic data releases, sterling remains vulnerable to global risk sentiment, yet the currency has shown resilience despite a modest increase in risk aversion in financial markets this week. GBP/USD continues to hold firm at $1.32, a level it has only surpassed for four days over the past two years, while GBP/EUR hovers near €1.19, a threshold exceeded for just 16 days in the same period.
In early August, the Bank of England (BoE) reduced its main rate by 25 basis points to 5%. Markets are currently anticipating an additional 40 basis points in cuts by the end of the year. However, stronger-than-expected UK economic data and cautious comments from BoE Governor Andrew Bailey on further rate reductions have moderated these expectations. Consequently, both 2-year and 10-year UK gilt yields have risen above 4%, enhancing the pound's yield advantage against most major currencies. While there is potential for further short-term weakening of sterling, GBP/USD has already corrected from overbought levels due to recent consolidation.
On the fiscal front, UK Prime Minister Keir Starmer has acknowledged the challenges ahead in addressing issues linked to the previous Conservative government, warning that conditions may deteriorate before they improve. The upcoming Autumn budget, along with anticipated tax increases, adds some uncertainty to the UK's growth outlook.
German Inflation Drops to Lowest Level Since 2021 as Eurozone Awaits Further Slowdown
Germany's annual inflation is expected to decrease to 2.1% in August, marking the lowest level since April 2021. Similarly, Eurozone inflation data, set to be released tomorrow, is projected to show a slowdown to 2.2% year-on-year, the lowest in over three years and down from 2.6% in July. Despite these indications of cooling inflation, market expectations for European Central Bank (ECB) rate cuts remain unchanged. Traders are holding steady on their bets, pricing in a 25bps cut next month, 65bps by the end of the year, and 157bps by the close of 2025.
The EUR/USD pair has retreated to a three-session low of around $1.112, extending its losses for the week. The pair has shed approximately 0.7% from its recent high but still remains nearly 3% higher for the month. With markets pricing in the bottom of the dollar smile scenario and no significant U.S. economic data this week, the dollar is likely to maintain its strength. Consequently, EUR/USD may struggle to climb back toward $1.120, with a potential retest of the $1.110 support level on the horizon.
