September FOMC outlook: The Fed is caught between conflicting forces

Macro

Christopher Dembik

Head of Macro Analysis

Summary:  Our expectations for the upcoming FOMC meeting.


  • A rate cut is a done-deal and has already been priced in by the market. Based on futures from the CME Group, the probably of a 25bps rate cut is at 82% and a status quo on rate is at 18%. Historically, the Fed has always gone with whatever over 61% of the market forecast.
  • The motivation for the Fed to lower rates will be mostly linked to external factors, e.g. trade war and more importantly tightened financial conditions at the global level due to US shortage. On this last point, we think it’s going to get worse (in the fall) before it gets better (in early 2020). USD funding problems are doomed to increase in coming weeks term due to the expected ramp up of USD treasury bill issuance following the compromise over the debt ceiling in past August. We should be ready for higher FRA-OIS spreads in September/October.
  • The market is not prepared to a hawkish cut. Over the past few weeks, future expectations of further cuts have receded due to positive US data, notably extremely strong core CPI and very solid retail sales for two months in a row. The Fed is in a very tricky situation as it is caught between two conflicting forces: positive domestic data and higher external headwinds. The central bank could prefer to remain careful regarding the macroeconomic outlook and opens the door to a pause, which would also have for advantage to reiterate the independence of the Fed from the White House.
  • What makes us nervous is the macroeconomic impact of Saudi oil disruptions on growth and inflation if it is prolonged more than a few weeks. We don’t think that it will weight much on the Fed monetary policy in the short term but, if disruptions last longer than we all expect, it could constitute a true game-changer. We have already observed a strong jump in inflation breakeven following Sunday’s events.
  • Strategic view: Given various risks that may emerge in coming weeks (Brexit, growth slowdown and US tariffs against Europe following the US victory in Airbus case) and the problem of dollar shortage, the broad USD index is likely to follow an upward trend in the medium term. Historically, period of USD shortage always had positive implications for DXY and negative implications for risk appetite.

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