Asia wrap: Don't expect the ECB to wax dovish

While the US CPI numbers came in hotter than expected, investors remain laser-focused on the deteriorating labor market. Only a few economists had forecast a 0.3% month-on-month core CPI jump for August, leaving markets a bit taken aback by the figure. However, the likelihood of a 25bps cut in September remains intact, with markets pricing in about 28bps, signaling preference for a modest reduction. The fact that the uptick in inflation didn’t spook markets suggests that investors are comfortable with the idea that the Fed is okay with inflation’s steady trajectory, even if it dimmed the prospects of a 50bps cut. The spotlight has shifted to the labor market, now the central focus for market participants.

Asian equities followed Wall Street’s lead, advancing on Thursday as global traders calmly anticipated next week’s Fed rate decision. The consensus for a 25bps cut is a relief for investors, who seem happy to see the end of the “jumbo cut” debate for now, knowing the Fed's playbook still leaves the door wide open for further easing. The "Fed put" is alive and well, ensuring that markets will get the larger cuts they crave sooner or later if needed.

Meanwhile, USD/JPY continues its rally, driven by a rebound in risk sentiment that’s pushing high-beta currencies vs the yen higher, bringing USD/JPY along for a more extended ride that rate differentials suggest.. The weaker yen fueled a solid bounce in Tokyo shares, with traders embracing the well-known relationship: a weaker yen boosts exports.

The mechanical bid under oil prices, thanks to concerns over potential hurricane-related production shutdown in the Gulf of Mexico, is also noteworthy. But as with most weather-driven oil rallies, this one probably won’t have long legs—expect a modest $2-$3 bounce before the momentum fades.

The big event in the FX world today is the ECB meeting. Traders are eagerly waiting to see if the bank leans hawkish or dovish, potentially endorsing an October rate cut. The outcome will dictate whether EUR/USD dives below 1.1000 or rallies towards 1.1100, with Euro bulls hoping for a more restrained ECB stance. The key question: has too much easing already been priced into the ECB curve, or is the market hitting the sweet spot?

In more detail, the US dollar has been trading on firmer ground during the Asian session, buoyed by the stronger-than-expected US CPI report for August. This has tempered market expectations for a 50bps cut when the Fed kicks off its easing cycle next week. While the CPI surprise is unlikely to halt the Fed’s cutting trajectory, it does make a faster pace of cuts less likely. The Fed will probably view the August CPI as a blip, considering the broader trend of slowing inflation, a loosening labor market, and falling commodity prices.

The lift in US yields and renewed risk appetite has pushed USD/JPY back towards 143.00 after hitting a fresh low of 140.70 yesterday. It’s been a bit of a rollercoaster, keeping everyone on the momentum train rather than placing firm directional bets—standard fare in our weekly FX playbook.

As for the euro, it has dipped against the US dollar ahead of the ECB policy meeting, bringing EUR/USD closer to the 1.1000 level. This move is driven more by a stronger dollar than euro weakness, although today’s widely expected rate cut offers little support for the single currency. While I don’t expect ECB President Christine Lagarde to wax overly dovish—she’s always cautious about protecting the euro—the euro remains one of the dirtier laundry items in FX’s basket. It will take a mix of better EU data surprises or continued US data misses to spark life in the euro bulls. That said, with the euro slightly oversold, there’s room for a EUR/USD bounce if the ECB walks back market expectations for an October rate cut.