The FX Trader: Dovish Fed drives USD weakness, but how far?

The FOMC meeting delivered the expected 25-basis point cut and was marginally more dovish than expected, which sparked a larger initial reaction than seemed justified on the surface, if only because the treasury market was struggling and US treasury yields were testing the top of the ranges across most of the US yield curve heading into the decision late Wednesday. The US dollar followed treasury yields lower, with the USD selling picking up in early US hours on Thursday, driving EURUSD to a 2-month high and nearly to 1.1750 as of this writing, USDCAD hitting new local lows and USDJPY volatile but moving lower. Some feared three or more hawkish dissenters, but only two of the regional Fed presidents on the committee dissented in favor of no cut, while Stephen Miran dissented dovish with his latest request for a 50-basis point cut.

The Fed’s dot plot was practically unchanged, with the median forecast looking for a single further rate cut next year, while the GDP forecast was revised a solid 0.5% higher for next year to 2.3%, while PCE inflation was revised slightly lower for the headline and core next year. So much for tariff-induced inflation… A lower inflation level combined with solid growth allows cover for positioning this as the last like rate cut for the cycle unless incoming data requires a change of course. Powell spoke somewhat dovishly of US official payrolls data likely over-reporting payrolls gains of late. Oh, and the Fed is quietly restarting QE to prevent the Fed Funds rate from rising above the upper bound.

Of course, if the economy (mostly the labor market) fails to cooperate and weakens from here, cuts will quickly be on the table at a coming meeting and may be on the table anyway once the new Fed leadership is on board after May of next year. The market is likely correctly anticipated that with or without strength returning to the US economy, the Fed will default to the dovish side – very slow to hike even if inflation starts raging again amidst a growth resurgence and far more aggressive cuts than are priced if the labor market stumbles. A Fed landing zone of 3.00-3.25% is currently in the price (in the forward curve right into the September time frame next year). But could be 3.50-75% (the current level) in a wildly strong growth scenario by then or 2.00-2.25% in an ugly labor market deceleration. We'll offer our base case soon (somewhere in between) in the next quarterly outlook. Stay tuned.

The Fed and the market are not as starved for data as previously, with some of the private measure of payrolls and other data points like the ISMs and others not painting an alarming picture on the economy, and the market may be willing to look through the November official non-farm payrolls data if it is weak next Tuesday, given flat numbers from the ADP and the government shutdown disruptions, while the bar is high for the CPI to spark concerns next Wednesday.

The recent rise in long bond yields in Japan, with some signs of contagion into Europe was the development that most quickly might have threatened to destabilized global markets had it continued and especially had it spread to the US treasury market. If the US economy heats up again, treasury yields could act as a speed limiter for both global equity markets and USD bears. For now – the plunge back into the range for the 10-year treasury benchmark is a green light for USD bears and might even have the key 154.50 area in USDJPY in play again if the yield momentum to the downside continues. Some of the treasury bid may also be coming from suddenly weak sentiment on the Oracle earnings that came after the close on Wednesday, reversing all of the happy vibes in risk sentiment that the dovish Fed had driven. Should

EURUSD rallied post-FOMC and followed through stronger in Thursday session. Next week is the last proper week for trading for the year, although markets can continue to move in the days adjacent to holidays and into year-end fixing flows. The obvious focus is now the nominal top up of the range way up at 1.1919, though that was a bit of a spike high, so this breakout and a close above 1.1800 starts to reset the focus higher still to 1.2000 and more.