Fed Rate Decision: Hawkish Signals or Dovish Surprises?
The US Federal Reserve is widely expected to deliver another 25-basis point rate cut later today, with markets assigning a 95% probability to this outcome. Consequently, market volatility is more likely to stem from the Fed’s updated dot plots and economic projections. Should the tone lean unexpectedly dovish, the USD could weaken, especially given its 6% rally this quarter.
Market sentiment is largely tilted toward a hawkish stance, supported by ongoing US economic strength and the potential for fiscal stimulus under President-elect Donald Trump. Recent data highlights this resilience: US composite PMI climbed to its highest level since March 2022, driven by strong performance in the services sector, while retail sales rose 0.7% month-on-month in November, following an upwardly revised 0.5% gain in October. These indicators point to robust consumer spending and business activity, prompting markets to scale back expectations for further rate cuts next year. The projected interest rate path now exceeds the Fed’s current dot plot, setting a high bar for additional easing.
Additionally, policymakers may revise their inflation outlook as they prepare to pause rate cuts in January. In September, only three FOMC members anticipated upside risks to core PCE inflation, but this assessment is likely to shift higher. However, if upgrades to the 2025/26 economic forecasts fall short of market expectations, the USD may face downward pressure.
Sterling Slips as UK Inflation Meets Expectations
The pound retreated from yesterday’s highs after UK headline inflation for November came in line with forecasts. While core inflation reached a three-month high, a closely watched measure of services inflation, important to Bank of England (BoE) policymakers, was slightly lower than anticipated. As a result, GBP/EUR has dropped below €1.20 at Interbank (IB), and GBP/USD has slid back under $1.27 IB.
This inflation release was the final major data point ahead of the BoE’s last policy meeting of 2024, scheduled for Thursday. Strong wage growth data from yesterday led traders to reduce expectations for BoE rate cuts next year, with markets now pricing in two cuts in 2025, down from three earlier this week. However, despite resilient wage growth and persistent inflation, signs of weakness in the labour market and slowing economic activity are fuelling concerns over stagflation. This growing uncertainty suggests sterling may find less support from elevated UK rates moving forward.
Euro Slides Below $1.05 Amid Strong US Data and German Political Turmoil
The euro dipped below the $1.05 IB level as stronger-than-expected US macroeconomic data and escalating German political uncertainty weighed on the currency. In November, political instability in Europe’s largest economies reached new highs, with governments either collapsing or operating in minority positions as fiscal deadlines loom.
France is projected to grow modestly by 0.2% in the first half of 2025, according to the Insee institute. However, Germany faces a potential third consecutive year of contraction in 2025, further clouding the region's outlook.
Key catalysts for the euro’s near-term direction include developments in German and French politics, as well as the Federal Reserve’s policy decision later today. A sustained break below $1.05 IB by the end of the week could signal deeper trouble for the currency.