The Fed may signal that it could use the “wait and see” approach this week, short EUR/USD?
Should the Fed follow through, it will have eased monetary policy by a collective 75 basis points.
When the Federal Reserve convenes in Washington this week, Chairman Jay Powell is widely expected to announce another quarter-point reduction to the central bank’s benchmark rate, the third of such a move in as many meetings.
Should the Fed follow through, it will have eased monetary policy by a collective 75 basis points. That threshold is an important one because it is the amount of easing that constituted the so-called “mid-cycle adjustment” of the mid-1990s — an easing cycle Fed officials have repeatedly referred to as a relevant guide today. Powell used this exact terminology in July when he announced the first interest rate cut since the financial crisis a decade ago, framing the move as an insurance cut against future economic weakness. Markets rapidly sold off, as investors were expecting the Fed to kick off a much more pronounced easing cycle. While Powell has avoided using that wording in subsequent public appearances, Fed officials have recently begun to reintroduce the idea by stressing that the central bank could benefit from pausing at its next meeting come December.
Meanwhile, Mr Powell, Vice-chairman Richard Clarida and New York Fed President John Williams have said each decision should be made “meeting by meeting.” For this reason, we reckon the Fed may also adopt a “wait-and-see approach” after its move this week, leaving rates unchanged in December and throughout 2020. Additional easing will only come with a “more significant-than-expected deterioration in economic conditions.”
Will the Bank of Japan ease?
Bank of Japan heightened expectations for this week’s meeting of its policy board, which concludes on Thursday, when it promised to “re-examine trends in activity and prices” in light of a possible loss of momentum towards its inflation objective of 2%. Investors widely interpreted that as a holding tactic that laid the ground for possible action. Since then, the economic picture has not become much clearer though. Japan’s export markets are weak but domestic demand remains fairly strong. Inflation has weakened a little, but inflation expectations are hard to read. Furthermore, employment rate is high and the financial markets are fairly strong. Most of all, the yen has remained within a tight trading range close to ¥108 to the dollar. The BoJ’s greatest fear is that interest rate cuts by the Fed and the European Central Bank would prompt a sharp rise in the yen as the yield on overseas assets become less attractive. So far, that risk has not materialised. As a result, markets now expect the BoJ to stay its hand this week, or else to make a relatively minor adjustment to policy.
Our Picks
EUR/USD – Slightly bearish
EUR/USD may drop towards 1.1025 as the Fed may appear hawkish this week.
USD/JPY – Slightly bullish
USD/JPY may rise towards 108.90 amid improving risk sentiment.
XAU/USD (Gold) – Slightly bearish.
We expect XAU/USD price to fall towards 1480 this week.
