Will that be the Last 25bp Hike from FED? What you need to know!

USD: US economy continues to show resilience as inflation pressures slow. 

The US dollar displayed continued strength in overnight trading, following a significant rebound observed yesterday. Consequently, the USD/JPY pair climbed back above the 140.00-level. The recent reversal of the US dollar weakness has been bolstered by an increase in US yields. Over the past week, the 2-year US Treasury bond yield rose by just over 20bps, as market participants scaled back expectations regarding the extent of the Fed's rate cuts next year. However, expectations for one final rate hike this month remained largely unchanged.

The implied yield on the December 2024 Fed Fund futures contract has risen approximately 30bps since July 13th, reaching around 4.09%. Despite this adjustment, the US rate market still anticipates the Fed cutting rates by over 100bps next year to ease the policy rate to more accommodative levels. These expectations for Fed rate cuts in the future are highly sensitive to incoming economic data, as many believe that we are approaching a turning point for Fed policy.

The recent surge in US yields was further supported by the release of economic data indicating that the US economy is proving more resilient to higher rates than initially anticipated. The decline in initial claims over the past month alleviated concerns of a sharp slowdown in the US labour market during the second half of this year. This month has seen a series of stronger-than-expected US economic data releases, the most significant since early 2021. The Atlanta Fed's GDP Now Forecast has recently risen to 2.4%, defying previous expectations of the US economy growing well below its potential in the first half of this year. This poses an upside risk to Bloomberg's current consensus forecast for Q2 GDP growth of 1.3%.

Despite the recent positive economic data, the US dollar has fallen to fresh year-to-date lows this month due to growing evidence of slowing inflation in the country. The slowdown in inflation is crucial in determining the US dollar's weakness. As inflation decelerates, the Fed gains confidence that current rates are appropriately restrictive. If inflation continues to approach the Fed's target level, it may create room for rate reductions next year. In summary, a combination of lower US rates in response to slowing inflation and a softer landing for the US economy is expected to unfavourably impact the performance of the US dollar.

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