The market does not seem to have fully returned to pre-crisis levels. The Fed is now likely to make deeper rate cuts than previously expected. However, the Fed’s expectations for December have been adjusted in recent weeks to match those of the ECB. This is despite the fact that the ECB has already cut rates and the Fed has not yet followed suit. In practice, therefore, the market still expects the Fed to cut rates by 50 basis points at one of the three remaining meetings this year, notes Commerzbank FX analyst Michael Pfister.
Three things you should know about this development
“As we emphasized several times last week, such a move by the Fed would likely require a (further) weakening of the labor market. Officials will likely move toward a 50 basis point cut only if the labor market continues to weaken toward job losses. If job growth remains moderate, the Fed is more likely to begin the rate-cutting cycle at 25 basis points.”
“The convergence of interest rate expectations from the Fed and the ECB does not suggest lower EUR/USD levels for the time being. Apparently the market no longer believes that the Fed has room for less severe interest rate cuts. However, this greater room for maneuver has been a clearly positive USD signal for some time. Unless there is a correction, i.e. the Fed’s interest rate expectations fall more sharply than those of the ECB, this is unlikely to change.”
“The pound sterling is finally having its big moment. Undeterred by the much more pronounced correction in interest rate expectations from the Fed and the ECB, the BoE is still expected to cut interest rates much more slowly. We have stressed here several times that the BoE will probably have less scope for rate cuts. And the fact that the market seems to hold a similar view speaks in favour of the pound for now.”
