Stocks firm, dollar subdued as market flirts with outsized Fed cut

British Pound

Reuters: The British pound gained slightly on Friday, adding to Thursday's rise off a three-week low against the dollar, as the focus shifted to next week's UK inflation data and central bank meeting. Sterling edged up on the day at $1.3146, just above the $1.3127 it reached on Thursday, when it closed 0.6% higher. The Bank of England is widely expected to keep interest rates on hold next week, with futures markets implying around an 80% chance that rates remain unchanged, after a 25 basis-point rate cut last month.

"We expect the MPC to maintain Bank Rate at 5.00% on 19th Sept meeting and expect the Committee to opt to maintain the current £100bn pace of stock reduction," analysts at Goldman Sachs said, referring to the Monetary Policy Committee. The next key input for the BoE will be UK inflation data released on Wednesday, the day before its policy announcement. On Wednesday this week, data from Britain's Office for National Statistics showed the UK economy stagnated in July, sending the pound to its lowest since Aug. 20. A Reuters poll of economists had forecast a 0.2% month-on-month expansion.

The British economy has however still shown more solid growth than the euro zone since the beginning of the year. Against the euro, the pound was flat at 84.42 pence. The European Central Bank lowered interest rates by 25 basis points on Thursday and signalled a "declining path" for borrowing costs in the months ahead as inflation slows and economic growth in the euro zone dwindles. Meanwhile, media reports reignited speculation about an outsized Federal Reserve rate cut next week.

Goldman Sachs analysts expect the BoE's Monetary Policy Committee to reevaluate its cautious approach later this year, seeing "compelling reasons for the MPC to accelerate the pace of easing as wage pressures moderate and underlying services inflation falls back." They also anticipate sequential rate cuts from November until Bank Rate reaches 3% in September 2025.

US Dollar

Reuters: The U.S. dollar fell on Friday to its lowest level in nearly nine months against the Japanese yen after media reports once again fuelled speculation the Federal Reserve could deliver a super-sized 50-basis-point interest rate cut at its policy meeting next week. Analysts said reports by the Wall Street Journal and Financial Times late on Thursday saying a 50-bp rate reduction is still an option, and comments from a former Fed official arguing for an outsized cut, caused a shift in market expectations.

The U.S. rate futures market has priced in a 51% probability of a 50-bp easing by the Fed at the conclusion of its two-day meeting on Wednesday, up from about 15% early on Thursday. Futures traders have also factored in 117 bps of cuts for 2024, up from 107 bps in the previous session. The media reports introduced the probability of a 50-bp cut back into the market after new inflation data had reinforced expectations of a 25-bp cut by the Fed, said Brad Bechtel, global head of FX at Jefferies in New York. "So you're just seeing a little bit of an unwinding of those positions that were looking for 25 basis points."

In late afternoon trading, the dollar was down 0.66% to 140.855 yen, after earlier dropping to 140.285, its lowest level since Dec. 28. On the week, it fell 1%. The euro, meanwhile, rose 0.08% versus the greenback to $1.1083. The European Central Bank cut interest rates by 25 bps on Thursday, but ECB President Christine Lagarde dampened expectations for another reduction in borrowing costs next month. Gains in the euro have pushed the dollar index 0.08% lower to 101.08. "That increase in probabilities of potentially more dovish Fed policy drove the dollar lower and pushed a lot of those other currencies higher, said John Velis, FX and macro strategist at BNY Mellon in Boston.

The dollar trimmed losses after data showed U.S. consumer sentiment improved in September amid easing inflation. The University of Michigan's preliminary reading on the overall index of consumer sentiment came in at 69.0 this month, compared with a final reading of 67.9 in August. Economists polled by Reuters had forecast a preliminary reading of 68.5. U.S. economic data this week appeared to support the case for a typical 25-bp cut next week, with the measure of consumer price inflation that strips out volatile food and energy prices rising more than expected in August.

But former New York Fed President Bill Dudley on Friday added to the speculation about a 50-bp Fed rate cut, saying there was a strong case for such a move and that rates were currently 150-200 basis points above the so-called neutral rate for the U.S. economy, where policy is neither restrictive nor accommodative. "Why don't you just get started?," he said. The euro "is eyeing $1.11 again after the combined support of a not-dovish-enough European Central Bank and rising dovish bets on the Fed," said Francesco Pesole, a currency strategist at ING.

Sterling edged slightly lower 0.01% to $1.31235, weakening after reaching near its highest level in a week. The Bank of England is expected to hold its key interest rate at 5% next week after kicking off its easing with a 25-bp reduction in August. The dollar fell 0.38% against the Swiss franc to 0.84780 francs. Investors were also looking to the Bank of Japan's interest rate decision next Friday, when it is expected to keep its short-term policy rate target steady at 0.25%.

BOJ board member Naoki Tamura said on Thursday the central bank must raise rates to at least 1% as soon as the second half of the next fiscal year, but added that it would likely do so slowly and in several stages. "The BOJ is perceived to be going in the different direction than the Fed - in 180-degree opposite direction," Velis said, adding that whether and when the BOJ raises rates remains an open question.

South African Rand

Reuters: The South African rand firmed on Friday against a weaker dollar, as markets weighed up bets on the size of a rate cut expected in the world's biggest economy next week. At 1539 GMT, the rand traded at 17.7275 against the dollar, about 0.2% firmer than its Thursday closing level. The dollar last traded softer against a basket of peers, as investors remained on tenterhooks ahead of next week's Federal Reserve meeting. "The spotlight is now on the Fed’s policy update next week, which will reveal just how concerned policy makers are over the U.S. economy’s outlook," said Danny Greeff, co-head of Africa at ETM Analytics.

While markets are certain the Fed will cut rates, uncertainty around whether it will go with a 25-basis-point or 50-basis-point cut remains. "I fear there is a risk of some short-term volatility for the rand given how aggressive the market's positioning is for rate cuts in the coming months," Greeff added, referring to rate cuts in developed economies. Like other risk-sensitive currencies, the rand often takes direction from global drivers such as U.S. monetary policy in addition to local data points.

This week, local investors will focus on August consumer inflation figures on Sept. 18 and the South African Reserve Bank's interest rate announcement on Sept. 19. Economists polled by Reuters predict the SARB will announce a 25 basis point rate cut. On the Johannesburg Stock Exchange, the blue-chip Top-40 index closed about 0.4% up. South Africa's benchmark 2030 government bond also firmed, as the yield slipped 8.5 basis points to 8.915%.

Global Markets

Reuters: Asian stocks dithered and the dollar slipped on Monday in a week that is almost certain to see the start of an easing cycle in the United States with investors flirting with the chance of an outsized move. Central banks in Japan and the UK also meet this week, with both expected to stand pat for now, while a packed data schedule includes U.S. retail sales and industrial production. Geopolitics loomed large as ever with Republican presidential candidate Donald Trump the subject of a second assassination attempt on Sunday according to the FBI.

Holidays in China, Japan, South Korea and Indonesia made for thin conditions and early moves were modest. MSCI's broadest index of Asia-Pacific shares outside Japan gained 0.3%, after bouncing 0.8% last week. Japan's Nikkei was shut but futures traded at 36,315 compared to a cash close of 36,581 as recent yen gains pressured exporters. S&P 500 futures were little changed, while Nasdaq futures dipped 0.1%. EUROSTOXX 50 futures added 0.2% and FTSE futures 0.1%. DAX futures also firmed 0.1%.

Economic data from China over the weekend disappointed as industrial output growth slowed to a five-month low in August, while retail sales and new home prices weakened further. "The data bolsters the case for additional economic stimulus by year-end if China wants to achieve its target of around 5% growth in 2024," said Vivek Dhar, a mining & energy analyst at CBA. "We think policymakers will look to boost central government spending on infrastructure projects if both China's property and infrastructure sectors sink again in September."

As for the Federal Reserve, futures rallied early to push the chance of a half-point cut to 59%, against 30% a week ago. The odds have narrowed sharply after media reports revived the prospect of a more aggressive easing. "We agree it is likely to be a close call, but we also believe the Fed will make the 'right' move and go 50bp," said JPMorgan economist Michael Feroli. "The case for a 50bp cut seems clear to us: various iterations of a Taylor Rule imply policy is currently a full percentage point or more too restrictive," he added.

If the Fed does go by half a point, Feroli expects policy makers to also project 100 basis points of cuts this year and 150 basis points for 2025. The market has 114 basis points of easing priced in by Christmas and another 142 basis points for next year. Analysts at ANZ noted that in the last three decades there have been three easing cycles that started off with a cut of more than 25bp, but in each there were concerns about a market rout leading to recession, which is not the case now.

Just the chance of an aggressive move saw bonds rally broadly, with two-year Treasury yields down at 3.593% having scored the lowest close since September 2022. The Bank of England is generally expected to leave rates on hold at 5.00% when it meets on Thursday, though markets have priced in a 31% chance of another cut. The Bank of Japan meets on Friday and is widely expected to hold steady, though it may lay the groundwork for a further tightening in October. South Africa's central bank is also tipped to ease policy this week, while Norway is seen holding steady.

The drop in Treasury yields has boosted the yen against the dollar, which eased to a near nine-month trough at 140.25 yen having slipped 0.9% last week. The euro was steady at $1.1096, with the prospect of more rate cuts from the European Central Bank keeping a lid on the currency at $1.1200. The Canadian dollar held at 1.3580 per U.S. dollar after Bank of Canada Governor Tiff Macklem opened the door to faster rate cuts in an interview with the Financial Times. Lower bond yields underpinned gold, which stood at $2,582 an ounce and near an all-time peak of $2,588.81. Oil prices were mixed as nearly a fifth of crude oil production in the Gulf of Mexico remained offline. Brent fell 4 cents to $71.57 a barrel, while U.S. crude firmed 7 cents to $68.72 per barrel.

Read more here