Central Bank Weekly: Has the Fed’s Dovish Shift Altered the Market’s Course?
- The Fed eliminated the chance of a 25-bps rate hike in 2019, but amid plummeting US Treasury yields, rates markets have pulled forward rate cut expectations to September 2019.
- Why hasn’t the US Dollar suffered? The Fed’s concerns are over global growth, which means the US Dollar’s appeal as a safe haven is being revived.
- Retail traders are increasingly betting against US Dollar strength.
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The March Fed meeting proved memorable after Fed Chair Jerome Powell threw in the towel on a potential rate hike in 2019, a significant climbdown from the December 2018 Summary of Economic Projections. But more than a week later, the effects of the shift in policy are still being felt across markets. The underlying cause for concern that prompted the Fed to tone down its hawkish rhetoric – that global growth is slowing amid heightened trade tensions – has provoked investors into a more risk-averse mindset, with the US Dollar rallying and US Treasury yields falling since last Wednesday.
Rates Markets Now Pricing in a September Cut
Even if the Fed has simply arrived at a place where the market has been for many months now – including prior to the 2018 US midterm elections (see section: How Quickly Do Traders Spot Shifting Fed Narrative?) – it’s clear that traders are taking cues from the Fed’s warnings about global growth. Immediately after the March Fed meeting, odds of a September cut jumped from 16% to 58% where they stand today.
Federal Reserve Rate Hike Expectations (March 28, 2019) (Table 1)
We can measure whether or not a rate cut is being priced-in for 2020 by examining the difference in borrowing costs for commercial banks over a one-year time horizon in the future. The spread between the Eurodollar June 2019 and 2020 contracts have fallen on nearly a straight line since the March Fed meeting:
Eurodollar December 2019/2020 Spread: Daily Timeframe (October 2018 to March 2019) (Chart 1)
The Eurodollar December 2019 and 2020 contract spread is up today, but is now pricing in -31-bps, more than a full cut, for 2020.
DXY Index Chart: Daily Timeframe (June 2018 to March 2019) (Chart 2)
Even as the DXY Index rally enters its fifth day over the past six sessions, neither bears nor the bulls have the upper hand. We’re sitting in the middle of a range that has been in place since October, and remain with the confines of the ascending triangle in place since November. Until 97.72 breaks to the topside or 94.96 breaks to the downside, there is little good reason to think that the US Dollar will do anything other than grind sideways – rising rate cut odds are being offset by a shift to the US Dollar as a safe haven.
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--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
To contact Christopher Vecchio, e-mail at email@example.com
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