FED Policy Expectations

Chair Powell provides the most definitive signal that the cycle of interest rate hikes for the USD has end.

The US dollar has experienced continued weakness in the Asian trading session, persisting from the sell-off observed in the previous week. Over the last three weeks, the dollar index has consistently closed lower, marking an overall decline of around -4.0% since reaching its peak in October.

The primary driver behind the recent sell-off was Federal Reserve Chair Powell's speech on Friday. In his address, Powell provided the strongest indication yet that the Fed was concluding its hiking cycle. He underscored a more balanced perspective on the risks associated with under- and over-tightening, advocating for a cautious approach in policy adjustments. Powell went on to characterize the current policy rate as "well into restrictive territory," suggesting that the complete effects of tightening policies might not have fully manifested.

Expressing confidence in the economy, Powell noted an improving balance between demand and supply in the labour market. He welcomed recent inflation readings that contributed to a slowing core inflation rate of 2.5% over the six months ending in October. However, he emphasized the necessity for continued progress to achieve the Fed's 2% inflation objective.

While Powell's comments align with the current market expectation of no further Fed hikes, he did mildly push back against the prevailing anticipation of aggressive rate cuts in the upcoming year. Powell stated that it would be premature to confidently conclude that a sufficiently restrictive stance had been achieved or speculate on the timing of potential policy easing.

Only 1% of the market believes on a hike on December 13

Source: CME

Despite this, Powell's remarks did not lead market participants to immediately adjust their expectations. The US rate market continues to fully price in a 25bps Fed rate cut by the 1st of May FOMC meeting, with a total of 125bps in rate cuts anticipated by the end of the next year. The implied yield on the December 2024 Fed fund futures contract adjusted sharply lower by approximately 44bps last week, reflecting the market's anticipation of more aggressive rate cuts in the coming year.

The main catalysts for this adjustment were comments from Fed Governor Waller, suggesting the possibility of rate cuts in the next three to five months, and a softer PCE deflator report for October. Looking ahead, the focus is on incoming US economic data, which needs to provide evidence supporting the expectation of slowing inflation and weakening demand to validate the dovish repricing.

Any deviation from these expectations could trigger a relief rally for US yields and the dollar. The pivotal moment for the recent dovish repricing will be the release of the latest non-farm payrolls report on Friday/Saturday. This report is expected to offer further evidence regarding the alignment of demand and supply in the Labor market.

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