Forex: Is it time for the Fed to adopt forward thinking?

As markets inch closer to the Fed's much-anticipated rate cut, the chances of a more aggressive move have ticked up, thanks in part to a timely article from a well-known WSJ Fed insider suggesting the size of the cut is still up for debate. Add in remarks from former FOMC member Bill Dudley, and suddenly dovish bets have surged ahead of next week’s decision. The OIS-implied probability of a 50bp cut has now jumped back to over 30%, sending the US dollar into a brief sell-off.

USD/JPY led the charge lower, as traders began pricing in a softer dollar amid expectations of an extended Fed rate cut cycle. While the pair has since clawed back some losses, Tokyo traders remain on high alert for BoJ guidance. Junko Nakagawa from the BoJ has signaled that more rate hikes could be on the horizon, with a 1% neutral rate for 2025. So, expect more currency fits and starts as traders hang on to every policy hint.

Meanwhile, traders are also keeping an eye on US election polls. Kamala Harris is pushing for another debate, while Donald Trump has so far resisted. With Harris being seen as more dollar-negative, her sustained bump in the polls could fuel further USD weakness.

Though the probability of a 50bp cut dipped to below 10% after the CPI print, it’s now rebounded to a one-in-three chance. For the FOMC to pull the trigger on a 50bps cut next week would be surprising but not shocking, as the market positions for all possible outcomes now. Whether this latest WSJ piece was a deliberate signal remains to be seen, but one thing’s clear—the decision is hanging in the balance.

EUR/USD is once again flirting with the 1.11 level, helped by a not-so-dovish ECB and rising expectations of a larger Fed cut. However, it’ll take stronger EU data or weaker US data to truly bring more Euro bulls to the table.

The Fed, meanwhile, has a chance to step out of the rate cut frenzy and establish itself as a forward-looking institution. A 50bp cut could be the bold move to tackle hidden employment risks and prove it’s ready to act decisively.