USD easing ahead of Fed rate decision

In focus today

We receive the German ZEW data for September today. The assessment of the current situation has been stuck at very low levels the past year and the expectations component has fallen in the past two months following a strong rebound. As risk sentiment in markets in September has been sour, we expect another weak ZEW reading.

From the US, August retail sales and industrial production data is due for release for August. This will mark the final piece of economic data before the Fed's September rate decision tomorrow, but it is unlikely to change the decision. We expect a 25bp case and guidance for more cuts to come.

Economic and market news

What happened yesterday

ECB's Kazimir and Kazaks commented on monetary policy. Kazimir said that ECB should wait with its next rate cut until the December meeting, to make sure not making policy mistakes in easing too quickly. He said that for him to back a rate cut in October he would require a powerful signal, but that is not likely to happen since there will be only little new information before the October meeting. Kazaks said that rates will continue to go down, and he sees no reason why not to agree with market pricing for 2025, so rates will hit 2.50% by mid-2025. We expect ECB to deliver its next rate cut at the December meeting.

USD eased yesterday with markets split between a 25 and 50 bp rate cut on Wednesday. In the absence of new data, markets shifted from pricing below 20% likelihood of a 50bp rate cut mid-last week to over 50%. EUR/USD ended yesterday around the monthly high of 1.113 mark. USD/JPY briefly fell below 140 on Monday morning, for the first time since last summer. Later it increased to above the 140 mark again. JPY has strengthened since early June when USD/JPY peaked around 161, as the Bank of Japan has signalled further rate cuts, while Fed and ECB have begun monetary easing cycle. We expect JPY to strengthen further and USD/JPY to decline steadily to 135 over the next 12 months.

Equities: Global equities were marginally higher yesterday, with defensive value stocks outperforming. Or perhaps more accurately, tech and consumer stocks underperformed. It is unusual to see defensive value sectors, including banks, outperform on a day when equities are higher, and yields are lower. This suggests that while investors still welcome lower interest rates, their appetite for tech has diminished. This shift is not due to weak earnings in the tech sector but likely because tech and similar sectors have reached a valuation premium that has investors increasingly looking elsewhere. To put it into perspective, tech has been the worst-performing sector over the last three months in a positive market, with financials outperforming tech by more than 10%. Similarly, value stocks have outperformed growth stocks by 7% over the last three months, despite US 10-year yields being down more than 50 basis points during the same period. Asian markets were very mixed this morning, with Japan emerging as the notable loser. US futures are marginally lower, while European futures are higher.

FI: Global rates fell further through the Monday session as markets added to rate cut expectations ahead of tomorrow's FOMC decision. OIS markets now have 39bp discounted, up from 34bp on the Friday close, despite the US Empire Manufacturing Survey printing much stronger than expected in yesterday's release. EGB curves generally saw a rather synchronized drop with the Bund curve down by some 2-3bp across tenors. Long-term EUR inflation swap rates (e.g. 5y5y) continued their rebound, as commodity prices seem to have bottomed for now.

FX: The USD started the FOMC week on the back foot, broadly weakening in the G10 space. This caused EUR/USD to trade above 1.11 and USD/JPY to breach 140 for the first time since July of last year. Scandies also gained against the USD but traded sideways against the EUR, with EUR/NOK remaining just below 11.80 and EUR/SEK just above 11.30. EUR/GBP edged lower during yesterday's session.