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Fed cuts rates again, but why is the dollar rallying?


The Federal Reserve has cut interest rates by another 25 basis points to 1.75%/2.00% in its meeting today. However, despite what would on the surface seem to be a dovish move, the dollar is strengthening. We look into why.

Federal Reserve symbol and US flag

 

The Key Takeaways

The Fed has continued on its cutting cycle, however there are signs that the Fed remains confident about the US economy. This seems to be at odds with a central bank cutting rates. This is reflected in the dot plots and economic projections. The Fed believes that the consumer remains strong even if business fixed investment is weak. This is a reflection that the US economy is riding out the storm of the trade dispute relatively well, thus far.

There are also deep divisions on the voting of the committee, whilst the dot plots are hinting at a potential pause in the cuts.

 

FOMC Statement changes

  • The statement was kept very similar to July, with the Fed seeing little need for any dramatic changes.
  • The main change at the top being of the assertion that “household spending rising at a strong pace”. Household spending accounts for around 70% of the US economy, so this is an encouraging aspect of the statement.
  • The only other real change is the line that “exports have weakened”. This is the balancing impact of the international slowdown and the trade dispute. It is also the only real reason behind why the rates are being cut right now.
  • The final change is with the number of dissenter. There are now three dissenters. The two hawks from July, Esther George and Eric Rosengren, continue to argue for no cuts. However, there is one at the other end of the scale, with uber-dovish James Bullard calling for -50 basis points of cuts.

 

Changes to dot plots

The dots have shifted to account for the two cuts that have now been made. However, it is interesting that the mean dot plot for 2019 and 2020 (down from 2.4% in June to 1.9% now) are the same as where the current rate is now in the middle of the current range 1.75%/2.00%.

It is also interesting that 5 of the dots called for no more cuts this year. There were two dissenters, but there could have been more (they were non-voters). But also there are seven calling for another cut (presumably in December).

Changes to Economic Projections

The economic projections are interestingly similar to June. That shows the Fed confidence in the domestic economy remains.

The prospect of future rate moves

It looks very much as though Powell’s “mid-cycle adjustment” of the July meeting remains viable, even though Powell is not willing to admit it. The dots and mean rate for 2019 and 2020 suggest there will be a battle to secure further cuts. This is now a very divided FOMC. This could be significantly different in December as the latest round of trade talks would have come and gone and the next phase could be underway (on the assumption that both side remain a long way apart). However, as things stand, another cut in December should not be taken for granted.

 

Market Impact

The market is taking this as a mild hawkish surprise, with yields up and the dollar gaining. The Dollar Index has gone up from 98.3 to 98.65 since the cut. Equities are also a shade weaker.

  • Treasury yields – A “bear flattener” where shorter dated yields are rising higher than longer dated. The 2 year yield is up 5bps whilst the 10 year is 2bps higher.
  • EUR/USD has fallen around -35 pips, with the choppy near term range still broadly between $1.1000/$1.1100 intact. However, a decisive close below $1.1000 would be a negative technical signal now.
  • GBP/USD has actually held steady and is a handful of pips higher. The uptrend higher of the past two weeks remains intact and sterling remains strong. The outlook remains bullish above $1.2380 support.
  • USD/JPY continues to rally and is around +25 pips higher and is looking to resume the run towards 109.00 again.
  • Gold has probably had the most significant reaction, with a -$20 move which has now broken the long four month uptrend. The bulls are now under growing pressure and the key range supports ($1481/$1485) are now in range.
  • S&P 500 has dropped by -15 ticks and the corrective move seems to be gaining momentum.

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At Hantec Markets Ltd we provide an execution only service. Any opinions expressed by analyst Richard Perry should not be construed as investment advice or an investment recommendation. This report does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. Forex and CFDs are leveraged products which can result in losses greater than your initial deposit. Therefore you should only speculate with money that you can afford to lose. Please ensure you fully understand the risks involved, seeking independent advice if necessary prior to entering into such transactions.