Last-minute positioning pre-FOMC sees sharp dollar selling – more to come?

USD: FOMC to push the dollar further lower?

The US dollar broke lower yesterday with EUR/USD hitting a new high of the year and the highest level since September 2021. We feel this move was due and there has been a long period in which the dollar was consolidating at lower levels and remaining in a range despite the fundamental backdrop pointing to renewed depreciation. In particular the steps taken recently that clearly undermines the independence of the Federal Reserve have unfolded with little impact on the dollar. With the FOMC meeting now upon us, the appetite for selling the dollar has picked up. Stephen Miran’s appointment to the FOMC board was approved on Monday evening and while Lisa Cook was cleared to attend this meeting, a cloud hangs over her role over the medium-term. We could well start to see more explicitly the impact of Trump’s actions in the details released this evening in the Summary of Economic Projections.

As usual there will be three key elements that the financial markets will focus on – the statement; the median dots profile in the SEPs; and Chair Powell’s press conference. The reference in the statement that “labour market conditions remain solid” is now very dated and the description of the jobs market will certainly see a downgrade. Most of the rest of the statement is likely to remain the same with the reference that inflation “remains somewhat elevated” still valid.

The SEPs will certainly be interesting and with Stephen Miran sworn in to his position on the Board of Governors yesterday, we can expect to see Miran’s dot profile in the SEPs. Surely his will be the lowest dot in the profile. In June the lowest dot for 2025 was 3.625% (two dots at that level), which implied three cuts. That level for the fed funds could now well be the majority level although it remains a close call on whether the median drops to show two further cuts (in addition to tonight’s) or just one further cut. While the dot profile for this year will trigger a market reaction, in reality whether the median shows one or two more cuts the spread of dots is likely to show that view within the FOMC being finely balanced. That suggests to us whatever the reaction to the dots profile, it may not prove sustained. By the end of next year and end-2027 the profile is likely to be lower and more similar to the March levels of 3.375% by end-2026 and 3.125% by end 2027. The level could feasibly be another 25bps lower which would be more consistent with the 1-year and 2-year OIS levels of 2.90% and 2.77% respectively.

Chair Powell’s job in the press conference is of course tricky given what Trump is attempting. In part due to that overt political pressure, while Powell is likely to be more dovish he will also be careful not to appear dismissive of the inflation risks. The jobs market will be clearly the focus and the cut (and possibly the dot profile) will need justifying but there will still be FOMC members concerned over delayed tariff-related inflation risks. The press conference will likely cover a question on whether a 50bp cut was discussed, especially if Miran and possibly Waller and/or Bowman vote for a 50bps cut. How serious that was discussed will be important and a sense of a serious debate would certainly push front-end yields and the dollar lower.

The dollar sell-off yesterday does highlight investor concerns that the front-end of the yield curve could still drop further. The OIS market is about 6bps short of pricing three 25bps cuts, one at each remaining meeting. Any sense of a 50bp cut is the downside risk for front-end rates and the dollar. Without that, the curve looks well priced and the dollar sell-off into the meeting could mean there’s a relief rally if the prospect of a 50bp cut is an idea that Powell is more clearly dismissive of.

SHARP DROP IN US 2YR YIELD SPREADS AS US JOBS MARKET WEAKENS

Source: Bloomberg, Macrobond & MUFG GMR

CAD: BoC set to cut too

The Canadian dollar is the worst performing G10 currency on a year-to-date basis after the US dollar and in September is also the worst performing, even weakening slightly against the dollar. The fundamental backdrop has deteriorated and with that expectations of renewed rate cuts have increased. The market is now fully priced for the BoC to deliver another 25bp cut at its meeting today, after keeping rates on hold at the last three policy meetings and the first cut since March.

The inflation data released yesterday should allow for the BoC to act today. The headline annual CPI rate did pick up from 1.7% to 1.9% in August, but the increase was less than expected. The median annual rate was unchanged at 3.1% and the trimmed mean rate fell from 3.1% to 3.0%. These levels of increase are not exactly consistent with price stability but will reassure the BoC that tariff-related risks are not becoming further evident in the data. PM Mark Carney also announced in August that he would drop the 25% retaliatory tariff on a range of imported goods that will further reduce BoC concerns over the inflation outlook.

But what will be most compelling in arguing the case for a cut today will be the labour market. Just as the US market turns weaker, the Canadian labour market has weakened sharply. After a 40.8k drop in jobs in July, the August data released this month revealed a further 65.5K drop. The unemployment rate increased to 7.1%, the highest since August 2021.

A 25bp cut today will take the policy rate to 2.50%, taking the cumulative easing in this cycle to 250bps. That means the BoC has been the most active G10 central bank in cutting rates along with the RBNZ. So in terms of guidance there will be no need for Governor Macklem to communicate strongly on the need for further rate cuts although another cut this year given the jobs market is certainly likely. But with inflation still high and given the extent of action by the BoC a balanced communication is likely.

With a cut fully priced and with another nearly priced by year-end, we doubt today’s decision to cut with a balanced communication will fuel CAD selling. The FOMC decision later will be more important and while CAD should gain given the poor prospects for the dollar, underperformance versus non-USD G10 is set to continue.

CANADIAN DOLLAR CONTINUES TO UNDERPERFORM VERSUS A G10 BASKET – HITTING THE WEAKEST LEVEL SINCE SEPT 2021

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com