The Federal Reserve’s (Fed) rate cut talk becomes chaotic and frankly, hard to follow. After the Fed signaled a possible end to its monetary policy tightening campaign and the European policymakers refused to adhere, some Fed members including John Williams and Raphael Bostic pushed back the Fed cut expectations.
Alas, activity on Fed funds futures price in the first Fed cut by March next year with more than 75% chance, and the first cut in May with almost a 100% chance. The market pricing matches the expectation of around 150bp cut throughout next year, versus only 75bp cut foreseen by Fed officials – which is already ambitious given the resilience of the US economic growth. Therefore, either the US economy will do fine, and the Fed won’t start cutting rates in March. Or we will see a sharp slowdown in the US growth and a potentially deteriorating growth outlook will force the Fed to start cutting the rates in Q1 and cut thoroughly. But a scenario where the Fed starts cutting rates in March while economy remains resilient and inflation low makes little sense as the fiscal spending will remain robust into next year’s presidential election and maintain the risk of a U-turn in inflation alive.
But anyway, investors could give the Fed doves the benefit of the doubt until Friday’s PCE data. The PCE, the Fed’s favourite gauge of inflation, is expected to show a further decline in both headline and core inflation. More importantly, if the data matches expectations, it would mean that 6-month annualized inflation will be a touch above the Fed’s 2% target. The latter could keep the Fed doves in charge. Nonetheless, the successful alleviation of inflation can be attributed to the decline in oil prices. Even though the base case scenario is a limited upside potential in oil prices, any reversal in oil price dynamics could tame the Fed cut expectations. In the short run, the barrel of American oil is around the $72pb on Monday on the back of lower Russian exports and suspended transit in the Red Sea due to attacks by the Houthis on ships in the region. Solid offers are seen into $74/75pb range.
What’s cooking in Japan?
The Bank of Japan (BoJ) will announce this year’s final policy verdict on Tuesday. The BoJ Governor Ueda’s comments that the BoJ’s policy would be hard to maintain from the year end, had triggered expectations that the BoJ will finally say goodbye to negative rates. There is nothing more than a slim probability for the BoJ to exit negative rates this week, but investors are eager to hear further details about how and when the BoJ will leave the negative rate territory. Concrete details regarding the BoJ’s policy plans and/or changes in BoJ’s inflation outlook could cause swift moves in yen markets, which became very volatile since Ueda hinted that something is cooking in its kitchen. The USDJPY fell from above 150 to nearly 140 in just two weeks. As such, the pair slipped – a bit too fast – into the bearish consolidation zone, below the major 38.2% Fibonacci retracement on this year’s rally.
The market’s position regarding the yen couldn’t be clearer. Presently, long Japanese yen is the most obvious trade in the currency markets. It is almost too easy. A hawkish signal from the BoJ has the potential to push the USDJPY below the 140 level, even with prevailing oversold conditions. Conversely, should the BoJ disappoint the market once more, any price rallies could draw the attention of top sellers.
