What the rate expectations tell us

The market does not seem to have fully returned to pre-crisis levels. Fed is now likely to deliver more rate cuts than previously expected. But, the Fed's expectations for December have been revised in recent weeks to be in line with those of the ECB. This is despite the fact that the ECB has already cut rates and the Fed has yet to follow suit. In practice, therefore, the market still expects the Fed to cut rates by 50 basis points at one of the three remaining meetings this year, Commerzbank’s analyst FX analyst Michael Pfister notes.

Three things to note about this development

“As we pointed out several times last week, such a move by the Fed would probably require a (further) weakening of the labor market. Officials are likely to lean towards a 50bp cut only if the labor market continues to weaken in the direction of job losses. If job growth remains moderate, the Fed is more likely to start the rate cut cycle with 25 basis points.”

“The fact that the Fed's and the ECB's rate expectations have converged does not support lower EUR/USD levels for the time being. Apparently, the market no longer believes that the Fed has room to cut rates less sharply. However, this greater room for manoeuvre has been a clearly positive USD signal for a long time. Unless this is corrected, i.e. the Fed's rate expectations fall more sharply than those of the ECB, this is unlikely to change.”

“Finally, the Pound Sterling is enjoying its moment in the sun. Undeterred by the much more pronounced correction in the Fed's and ECB's rate expectations, the BoE is still expected to do much less. We have stressed here several times that the BoE is likely to have less room to cut rates. And the fact that the market seems to be taking a similar view speaks in favour of the pound for the time being.”

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