One of the main events of this week is the regular meeting of the Federal Reserve System (FRS) of the United States, the results of which will be known today and can set the direction of movement not only for the dollar, but for other leading currencies until the end of the year.
The fact that at the end of the July meeting, the Fed will announce the first interest rate reduction in the last decade practically leaves no one in doubt.
At first glance, there are no actual reasons for the Fed to cut rates: the US economy is growing at an average rate, the unemployment rate is near historic lows, and the US stock indexes are at record highs.
The regulator began to prepare the markets for a similar step in June. The arguments to mitigate the monetary rate are called weak inflation and the escalation of trade tensions, which darkens the prospects for the global economy.
“In our opinion, the real reason why the American Central Bank is set to reduce the rate is that it is rapidly losing leverage over the national economy. In addition, according to US President Donald Trump, other central banks are already winning a competitive devaluation competition (the so-called currency war). And the very fact that the Fed’s dramatic shift in plans has not weakened the USD is already a motivation and forces the Fed to take measures, “Saxo Bank believes.
The actual question remains: will the Fed at the next meeting reduce the rate by 25 points or 50 basis points at once?
“Despite the fact that macroeconomic statistics for the United States has recently improved somewhat, for the Fed now, rather, it is not the assessment of the current state of the economy that is important, but its perspective. The regulator has already stated concerns about uncertainty in trade issues. Therefore, we believe that the rate in July will be reduced by 0.5%, “said analysts at Morgan Stanley.
The last time the American Central Bank reduced the rate by 50 basis points at the beginning of the mitigation cycle in September 2007, and the decline in the American economy began three months later.
No less important for investors will be the signals of the regulator on the next steps. They expect the Fed to cut its rate by 100 basis points by mid-2020, but this is seriously at odds with the current consensus forecast of the regulator. Market participants fear that after one or two cuts to the end of 2019, the Fed will pause to assess the effect and state of the economy.
“Probably, we will not see the degree of easing of monetary policy by the Fed, which is now included in the prices. Investor expectations have become too optimistic, “said Aberdeen Standard Investments.
There are 4 possible scenarios and the reaction of the dollar:
1. Reducing the rate for preventive purposes
This option seems most likely in the light of recent US macroeconomic indicators.
If the statement of the US Central Bank following the July meeting and the comments of Fed Chairman Jerome Powell at a press conference will make it clear that the regulator views the current rate cut as a “preventive” measure and does not seek to further weaken monetary policy, the dollar can be strengthened across the front, especially against the euro. Another “victim” could be a pound sterling, suffering from the uncertainty associated with the prospects of Brexit. At the same time, the yen is unlikely to suffer much, since Wall Street is clearly not happy with this news, and the decline in stocks will restrain the growth of USD / JPY .
2. Reduction rates and “open door” to further mitigate
The Fed may well hint at a potential rate cut, but keep silent about its scope. Here, J. Powell will probably note growing uncertainty, including in the sphere of world trade, and will not rule out further changes in the level of interest rates in the current year.
In this case, the greenback can be cheaper across the spectrum. The growth of USD / JPY will depend on the dynamics of the stock markets, and the euro is unlikely to be able to significantly strengthen, since in the near future market participants expect aggressive easing of the ECB monetary rate.
3. Reduction of the rate by 50 basis points
The Fed may take a similar step to calm the market. And even if the regulator’s management says that no further changes in the level of the rate are foreseen, such a significant decrease will adversely affect the dollar rate and provoke a stock market rally.
Commodity currencies, such as loonie and azzy, can become leaders because of the risk-taking, while defensive assets, by contrast, will become outsiders.
However, this option is unlikely, since the situation will look as if the regulator has succumbed to pressure from the White House. In addition, a strong reduction in rates will raise questions about the state of the American economy.
4. No downgrade
Despite the fact that such a decision would contradict the previous signals of the American Central Bank, it should not be absolutely excluded either.
It is assumed that the Fed is so inspired by the latest positive statistics from the United States that it decides to keep the status quo and leave the door open to cut rates in September. In this case, the dollar will rally, and the stock market will collapse. Along with stocks at the peak, commodity currencies can go, followed by the euro and pound. Only traditional safe-haven assets – the yen and the franc – will remain in relative safety.