A Fed rate cut seems almost certain, but how big will it be?

VaselineSeptember 18, 2024

0 6 minutes read

A Fed rate cut seems almost certain, but how big will it be?

The Federal Reserve is expected to lower the monetary policy rate after the September meeting.
The revised summary of economic projections and remarks from Fed Chairman Powell could provide important clues about the outlook for rates.
The US dollar faces two-way risk depending on the size of the interest rate cut.

The US Federal Reserve (Fed) will announce monetary policy decisions following the September policy meeting and will publish the Summary of Economic Projections (SEP), the so-called dot plot, on Wednesday. Market participants widely anticipate the US central bank will cut its policy rate, but the size of the cut is up in the air.

The CME FedWatch tool shows that markets are currently pricing in a near 60% chance of a 50 basis point (bps) rate cut versus a near 40% chance of a 25bps cut. Market positioning suggests that the US dollar (USD) faces two-way risk heading into the event.

The US Bureau of Labor Statistics reported last week that the core consumer price index (CPI), which excludes volatile food and energy prices, rose 0.3% month-on-month in August. This reading followed July’s 0.2% increase and beat market expectations of 0.2%. Following this report, investors saw a diminishing chance of a big rate cut.

In an article published a day later on September 12, The Wall Street Journal reporter Nick Timiraos, who is widely seen as a “Fed insider”, wrote that the size of the Fed’s interest rate cut at the September meeting will be a close call. In addition, annual producer inflation, as measured by the change in the producer price index (PPI), fell to 1.7% in August from 2.1% a month earlier. Markets have shifted their view to a 50bps cut, which has put the US dollar under renewed selling pressure.

Fed meeting preview, “the FOMC is expected to begin its easing cycle next week, with the Committee cutting rates by 25 bp. The decision to cut between 25bps and 50bps will be close,” TD Securities analysts said in a recent report and added:

“In our view, the dot chart will be the most prominent part of Fed guidance next week, along with Chair Powell post-meeting. We expect the Fed’s forward guidance to lean heavily in line.”

Frequently asked questions about the dot plot

“Dot Plot” is the popular name for interest rate forecasts by the Federal Open Market Committee (FOMC) of the US Federal Reserve (Fed), which implements monetary policy. They are published in the Summary of Economic Projections, a report in which FOMC members also publish their individual projections for economic growth, the unemployment rate, and inflation for the current year and beyond. The document consists of a chart showing interest rate projections, with each FOMC member’s forecast represented by a dot. The Fed also adds a table summarizing the forecast range and median for each indicator. This makes it easier for market participants to see how policy makers expect the US economy to perform in the short, medium and long term.

The US Federal Reserve publishes the “Dot Plot” once every two meetings, or four out of eight scheduled annual meetings. The Summary of Economic Projections report is published together with the monetary policy decision.

The “Dot Plot” provides a comprehensive view of expectations from Federal Reserve (Fed) policymakers. Because the projections reflect each official’s projection for interest rates at the end of each year, it is considered a key forward-looking indicator. By looking at the “Dot Plot” and comparing the data to current interest rate levels, market participants can see where policymakers expect rates to go and the overall direction of monetary policy. As the projections are published quarterly, the “Dot Plot” is widely used as a guide to find out the terminal rate and the possible timing of a policy pivot.

The most market moving data in the “Dot Plot” is the federal funds rate projection. Any change compared to previous projections is likely to impact the valuation of the US dollar (USD). In general, if the “Dot Plot” shows that policy makers are expecting higher interest rates in the near term, this tends to be bullish for the USD. Also, if forecasts point to lower rates in the future, the USD is likely to weaken.

When will the Fed announce its interest rate decision and how could it affect EUR/USD?

The US Federal Reserve is scheduled to announce its interest rate decision and monetary policy statement alongside the SEP on Wednesday 18 September at 18:00 GMT. This will be followed by Fed Chairman Jerome Powell’s press conference starting at 18:30 GMT.

The interest rate decision is likely to trigger immediate market reaction. A 25bps rate cut is likely to provide a boost to the USD, while a 50bps cut would have the opposite effect on the currency’s valuation. Following a strong reaction, the revised SEP could have a more lasting impact on the USD.

The June batch of points showed that 4 of 19 officials saw no rate cut in 2024, 7 projected a 25 bps rate cut, while 8 marked a 50 bps cut in the policy rate. If the new dot-plot shows that policymakers see the policy rate 100 bps below the current rate of 5.25%-5.5% at the end of the year, the USD could still be under pressure even if the Fed opts for a discount of 25 bps. because that would involve three consecutive rate cuts in the last three meetings of the year, including September, and one of them being a 50 bps cut. If the Fed opts for a 25 bps cut and the dot plot points to two more 25 bps cuts in November and December, the USD could gain more strength.

Investors will also pay close attention to Chairman Powell’s comments in the post-meeting press conference. If the Fed opts for a 25 bps cut, but Powell says in a press release that it was a close call with some policymakers arguing in favor of a big cut, the USD could struggle to hold on to its strength. Powell’s comments on the growth outlook could also influence risk perception and USD performance. If Powell takes a pessimistic tone on the economic outlook and sees a recession risk, risk-off flows could dominate markets. In this scenario, USD is likely to find demand as a safe haven.

In short, the September Fed event will have too many moving parts and will certainly increase market volatility. It may be too risky for investors to take large positions right after the Fed and may opt to wait until the dust settles.

Eren Sengezer, European Session Lead Analyst at FXStreet, provides a short-term technical outlook for EUR/USD:

“Following the pullback seen in the first half of September, EUR/USD has turned bullish, with the relative strength index (RSI) on the daily chart climbing towards 60. Additionally, the pair has recovered above its 20-day simple moving average ( SMA ) after closing below it for five consecutive days, reflecting increasing buyer interest.”

On the upside, 1.1200 (static level, end of July-August uptrend) lines up as first resistance before 1.1275 (July 18, 2023 high) and 1.1360 (January 2022 static level). If the pair breaks back below 1.1090-1.1080 (20-day SMA, Fibonacci 23.6% retracement) and starts using this area as resistance, technical sellers could take action. In this scenario, the next support could be seen at 1.1000-1.0980 (Fibonacci 38.2% retracement, 50-day SMA) before 1.0940 (Fibonacci 50% retracement).

Frequently asked questions about US dollars

The US dollar (USD) is the official currency of the United States of America and the “de facto” currency of a significant number of other countries where it is found in circulation alongside local banknotes. It is the world’s most heavily traded currency, accounting for more than 88% of total global foreign exchange turnover, or an average of $6.6 trillion in transactions per day, as of 2022. After World War II world, the USD has taken over from the British pound as the world’s reserve currency. For most of its history, the US dollar was backed by gold, until the Bretton Woods Agreement in 1971, when the gold standard disappeared.

The most important factor influencing the value of the US dollar is monetary policy, which is shaped by the Federal Reserve (Fed). The Fed has two mandates: to ensure price stability (inflation control) and to promote full employment. Its main tool for achieving these two objectives is the adjustment of interest rates. When prices rise too fast and inflation is above the Fed’s 2% target, the Fed will raise rates, which helps the value of the USD. When inflation falls below 2% or the unemployment rate is too high, the Fed can lower interest rates, which affects interest rates.

In extreme situations, the Federal Reserve can also print more dollars and engage in quantitative easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used when credit has dried up because banks will not lend to each other (for fear of default). It is a last resort when simply lowering interest rates is unlikely to achieve the desired result. It was the Fed’s preferred weapon to combat the credit crunch that occurred during the Great Financial Crisis of 2008. This involves the Fed printing more dollars and using them to buy US government bonds, mainly from financial institutions . QE usually leads to a weaker US dollar.

Quantitative tightening (QT) is the reverse process whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal of maturing bonds it holds in new purchases. It is usually positive for the US dollar.

VaselineSeptember 18, 2024

0 6 minutes read

Frequently asked questions about the dot plot

When will the Fed announce its interest rate decision and how could it affect EUR/USD?

Frequently asked questions about US dollars

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