【MACRO Alert】Federal Reserve Interest Rate Cut Expectations and the US Dollar's Trajectory - Financi

Recently, major financial institutions, including Citigroup and JPMorgan Chase, have predicted that the Federal Reserve may implement a 50 basis point interest rate cut this month. This forecast is primarily based on an in-depth analysis of US economic indicators, especially predictions for the upcoming non-farm employment data. However, the market is divided on this prediction; interest rate swap contract data suggests that the market estimates a 35% probability of a 50 basis point rate cut by the Federal Reserve, while a 25 basis point cut is more widely supported by market participants. This uncertainty has led to fluctuations in the Treasury market, especially after last month's employment data fell short of expectations, causing a period of turmoil in the market.

Matthew Raskin, head of US interest rate research at Deutsche Bank, pointed out that the market's uncertainty is expected to be resolved within the week. Federal Reserve Chairman Powell pays special attention to the performance of the labor market, considering it key to adjusting monetary policy. The job vacancy data for July and the employment growth data from the ADP private sector were both below expectations, reinforcing the market's expectation that the Federal Reserve might take a more substantial rate cut. After the upcoming employment report, the Federal Reserve will enter a quiet period, during which it refrains from making any comments on policy. According to data from Deutsche Bank, over the past 15 years, the market's expectations at the start of the quiet period have usually been very close to the Federal Reserve's final decision. Currently, the market anticipates a rate cut of about 34 basis points, indicating that this week's swap market may experience significant volatility.

In addition, as the market expects the Federal Reserve to cut interest rates, the downward trend of the US dollar is accelerating. The US dollar has fallen 5% from its 2024 peak, approaching its lowest level in a year. The strong US economy and high inflation rates had made US interest rates higher than those of other countries, attracting investors to hold US dollar assets. However, as inflation slows down, the market expects the Federal Reserve to cut rates at its September meeting, which may reduce the yield advantage of the US dollar.

Brian Rose, a senior US economist at UBS, believes that once the Federal Reserve begins to cut interest rates, the US dollar may depreciate. This could make US exporters more competitive in the international market and reduce the cost for multinational companies to convert overseas earnings into US dollars. However, the long-term trend of the US dollar will depend on the pace of future rate cuts by the Federal Reserve and whether other central banks follow suit. The market is betting on a more substantial rate cut by the Federal Reserve, expecting a possible 100 basis points cut within the year. Despite the US economy showing more resilience than other countries, the yield gap between 10-year US Treasury bonds and German bonds remains large. Nevertheless, investors' net short positions in the US dollar have reached $8.83 billion, marking the first time in six months that they have turned net short.

The US government's upcoming release of the August employment report may provide clues as to whether the job market is deteriorating further. In the short term, the US dollar may stop falling further due to the 2.2% drop in the US dollar index in August, and some analysts believe the market may be overreacting. Helen Given, co-head of trading at Monex USA, said that while the Federal Reserve's actions in September could lead to a weaker US dollar in the fourth quarter, the current trend may be somewhat excessive. Monex predicts that by June 2025, the euro-to-US dollar exchange rate will reach 1.13, indicating a possible 2% depreciation of the US dollar.

Many analysts are waiting for more evidence to confirm the trend of the US economy slowing down before taking a more negative view of the US dollar. Investors are also watching the results of the November US presidential election, which could impact the US dollar. Current polls show a very close race between Republican candidate Trump and Democratic candidate Harris. Trump has always criticized the strong US dollar for harming US competitiveness, but some of his policies, such as tariffs and tax cuts, could actually support a stronger US dollar. Comments from Standard Chartered Bank pointed out that if Harris is elected, higher tax policies might be implemented, and if economic activity slows down, it could put more pressure on the Federal Reserve to cut rates.

As market expectations for Federal Reserve rate cuts continue to increase, economists and investors are closely monitoring the release of economic data, looking for clues that might affect the magnitude of rate cuts. George Lagarias, chief economist at Forvis Mazars, said that although it is widely expected that the Federal Reserve will start cutting rates at its September meeting, he prefers to support a 25 basis point rate cut. Lagarias warned that a 50 basis point rate cut might send the wrong signal to the market, increasing the risk of economic recession.

The downward trend of the US dollar is accelerating, with the market expecting the Federal Reserve to cut interest rates soon, which could end the dollar's strength over the years. The US dollar has fallen 5% from its 2024 high, approaching its lowest level in a year. The strong US economy and persistent inflation had led to higher interest rates than other countries, attracting investors to hold US dollar assets. However, as inflation cools down, the market expects the Federal Reserve to cut rates at its September meeting, which could weaken the yield advantage of the US dollar.

Brian Rose of UBS stated that once the Federal Reserve starts cutting interest rates, the US dollar might depreciate. This could make US exporters more competitive in the international market and reduce the cost for multinational companies to convert overseas earnings into US dollars. However, the long-term trend of the US dollar will depend on the pace of future rate cuts by the Federal Reserve and whether other central banks follow suit. Despite the market's expectations for a Federal Reserve rate cut at this month's policy meeting, bets on a 50 basis point cut have increased after the job vacancy data was announced. Currently, there is about a 59% chance of a 25 basis point rate cut by the Federal Reserve in September, and a 41% chance of a 50 basis point cut.

Lagarias emphasized that although the economy is slowing down, he believes the US is far from a recession. He pointed out that although job vacancies and manufacturing are weak, this is an expected slowdown and there is no evidence of a recession. At this point, he believes the Federal Reserve will not take very aggressive action. Investors are betting on a more substantial rate cut by the Federal Reserve, expecting a possible 100 basis points cut within the year. However, the US economy shows more resilience than other countries, and the yield gap between 10-year US Treasury bonds and German bonds remains large. Helen Given of Monex USA stated that although the Federal Reserve's actions in September could lead to a weaker US dollar in the fourth quarter, the current trend may be somewhat excessive. By June 2025, the euro-to-US dollar exchange rate is expected to reach 1.13, indicating a possible 2% depreciation of the US dollar.

With the continuous changes in the global economy and the uncertainty of domestic politics in the United States, the future trend of the US dollar is full of unknowns. Although the market currently has high expectations for Federal Reserve rate cuts, the final policy decision will depend on the upcoming economic data and the global economic environment. The market continues to closely monitor the dynamics of the Federal Reserve and the health of the US economy. In addition, as the US presidential election approaches, political factors may also have a significant impact on the US dollar. At this critical moment, market participants need to stay alert and respond flexibly to various economic and policy changes that may occur to ensure competitiveness and profitability in the ever-changing global financial market.