US Federal Reserve to start easing cycle as markets face split rate cut expectations

• The Federal Reserve is widely expected to lower the policy rate after the September meeting.
• The revised Summary of Economic Projections and Fed Chairman Powell’s remarks could provide important clues about the rate outlook.
• The US Dollar faces a two-way risk depending on the size of the interest rate cut.

The US Federal Reserve (Fed) will announce monetary policy decisions following the September policy meeting and release the revised Summary of Economic Projections (SEP), the so-called dot plot, on Wednesday. Market participants widely anticipate that the US central bank will lower the policy rate, but the size of the cut is up in the air.

The CME FedWatch Tool shows that markets are currently pricing in a nearly 60% probability of a 50 basis points (bps) rate cut against a nearly 40% chance of a 25 bps reduction. The market positioning suggests that the US Dollar (USD) faces a two-way risk heading into the event.

The US Bureau of Labor Statistics reported last week that the core Consumer Price Index (CPI), which excludes volatile food and energy prices, rose 0.3% on a monthly basis in August. This reading followed the 0.2% increase recorded in July and came in above the market expectation of 0.2%. Following this report, investors saw a diminishing chance of a large rate cut.

In an article published a day later, on September 12, The Wall Street Journal reporter Nick Timiraos, who is widely seen as a “Fed insider,” wrote that the size of the Fed’s rate cut at the September meeting will be a close call. Additionally, the annual producer inflation, as measured by the change in the Producer Price Index (PPI), declined to 1.7% in August from 2.1% a month before. Markets shifted their view toward a 50 bps cut, which caused the US Dollar to come under renewed selling pressure. 

Previewing the Fed meeting, “the FOMC is widely expected to start its easing cycle next week, with the Committee reducing rates by 25bp. The decision to cut between 25bp vs 50bp will be close,” TD Securities analysts said in a recently published report and added: 

“In our view, the dot plot will be the most prominent part of the Fed's guidance next week, along with Chair Powell's post-meeting presser. We expect the Fed's forward guidance to lean broadly dovish.”

When will the Fed announce its interest rate decision and how could it affect EUR/USD?

The US Federal Reserve is scheduled to announce its interest rate decision and publish the monetary policy statement alongside the SEP on Wednesday, September 18, at 18:00 GMT. This will be followed by Fed Chairman Jerome Powell's press conference starting at 18:30 GMT. 

The interest rate decision is likely to trigger the immediate market reaction. A 25 bps rate cut is likely to provide a boost to the USD, while a 50 bps reduction would have the opposite effect on the currency’s valuation. Following a knee-jerk reaction, the revised SEP could have a more lasting impact on the USD.

June’s dot-lot showed that 4 of 19 officials saw no rate cuts in 2024, 7 projected a 25 bps rate reduction, while 8 marked down a 50 bps cut in the policy rate. In case the new dot-plot shows that policymakers see the policy rate 100 bps below the current rate of 5.25%-5.5% at the end of the year, the USD could still come under pressure even if the Fed opts for a 25 bps cut because that would imply three consecutive rate reductions in the last three meetings of the year, including September, and one of them being a 50 bps cut. If the Fed opts for a 25 bps cut and the dot-plot points to two more 25 bps cuts in November and December, the USD could gather further strength.

Investors will also pay close attention to comments from Chair Powell in the post-meeting press conference. In case the Fed goes for a 25 bps cut but Powell says in the presser that it was a close call with some policymakers arguing in favor of a large cut, the USD could struggle to preserve its strength. Powell’s remarks on the growth outlook could also influence the risk perception and the USD’s performance. If Powell adopts a pessimistic tone about the economic outlook and notes a risk of recession, risk-off flows could dominate the markets. In this scenario, the USD is likely to find demand as a safe haven.

In summary, the September Fed event will have too many moving parts and surely ramp up market volatility. It could be too risky for investors to take large positions in the immediate aftermath of the Fed and they could opt to wait until the dust settles.

Eren Sengezer, European Session Lead Analyst at FXStreet, provides a short-term technical outlook for EUR/USD:

“Following the pullback seen in the first half of September, EUR/USD has turned bullish, with the Relative Strength Index (RSI) on the daily chart rising toward 60. Additionally, the pair recovered back above the 20-day Simple Moving Average (SMA) after closing below it for five consecutive days, reflecting growing buyer interest.”

On the upside, 1.1200 (static level, end-point of July-August uptrend) aligns as the first resistance before 1.1275 (July 18, 2023, high) and 1.1360 (static level from January 2022). In case the pair returns below 1.1090-1.1080 (20-day SMA, Fibonacci 23.6% retracement) and starts using this area as resistance, technical sellers could take action. In this scenario, the next support could be spotted at 1.1000-1.0980 (Fibonacci 38.2% retracement, 50-day SMA) before 1.0940 (Fibonacci 50% retracement).