The US dollar held on to a two-and-a-half-month high on Tuesday amid expectations that the Federal Reserve will adopt a measured approach to cutting interest rates, while the crucial battle in the upcoming US election kept investors on edge.
The strength of the dollar, boosted by rising US Treasury yields, maintained pressure on the yen, euro and pound sterling, a topic that has grown over the past few weeks as data showed the US economy remained in a good place, causing traders to scale back bets on a significant and rapid rate cut by the Federal Reserve.
Four Federal Reserve policymakers on Monday expressed support for further rate cuts, but appeared to disagree on how quickly or how quickly they think any cuts should reach.
The divergent views provided a glimpse of what we might expect at the Fed’s next policy meeting on November 6-7.
Markets are considering the 89% probability that the Fed will cut interest rates by 25 basis points next month, versus 50% odds a month ago, when investors saw equal prospects for a larger 50 basis point cut, and traders expect an overall easing of 41 basis points for the rest of the year, as the Fed began its rate cut cycle with a 50 basis point cut in September..
Analysts at Goldman Sachs said in a note: “We believe back-to-back cuts of 25 basis points are very likely in November and December, but we see more uncertainty about pace next year.
The dollar index, which measures the greenback against six competitors, was at 103.96 in Asian hours, having touched its highest level of 104.02 since August 1 on Monday. The index is heading for a gain of more than 3% per month.
Dollar Rises and Rate Cuts Await Fed Split
The US dollar rose slightly on Tuesday, pushing the US Dollar Index (DXY), which measures the value of the US dollar against six major currencies, to a new 11-week high after US stocks retreated from all-time highs. US Treasuries are also selling and markets appear to be starting to reprice expectations of interest rate cuts, with odds rising that the Federal Reserve) will cut interest rates again this year before entering wait-and-see mode.
On the US economic front, markets await a very light calendar on Tuesday. However, one conclusion comes from Fed spokespersons where there is a clear divergence of opinions within the Federal Open Market Committee (FOMC), with Atlanta Fed President Rafael Bosic appealing not to cut interest rates anymore this year while San Francisco Fed President Mary Daly commented on Monday that the Fed needs to move forward. Move forward with the cycle of cutting interest rates and facilitate them further. Market participants are eager to see what Philadelphia Federal Reserve President Patrick Harker thinks about this on Tuesday.
The US dollar index (DXY) is trading between two flat levels on Tuesday after breaking a bearish fortress, which came in the form of a 200-day simple moving average (SMA) at 103.80 on Monday. Unfortunately, the level of 103.99/104.00 was too heavy to break through on the first attempt. If markets set rates for lower interest rate cuts from the Fed, expect 105.00 to appear fairly quickly in the US dollar index.
A further rally would trigger some resistance near 105.89 (May 2 high and a bearish trend line) before considering 106.00.
USD/CAD is flat, and expectations of a significant rate cut
The Canadian dollar was unchanged on Tuesday. In the European session, the USD/CAD is trading at 1.3831 at the time of writing. The Canadian dollar is under pressure and is going through a miserable October, falling 2.2%.
Bank of Canada expected to cut interest rates by 50 basis points
The Bank of Canada is making its next rate decision on Wednesday and the central bank is widely expected to cut rates for the fourth time this year. Will the Bank of Canada offer a modest 25 basis point cut as in previous meetings, or will it opt for a strong 50 basis point cut?
Markets expect a significant cut of 50 basis points, as economic growth has been weak, wage growth remains high and inflation is trending downward. Inflation fell to 1.6% year-on-year in September, below expectations and falling below the Bank of Canada’s 2% target for the first time in three years.
With inflation largely contained, the Bank of Canada is closely watching the employment front, but this has made the price trajectory more complicated. The September employment report showed a strong increase in job growth and a decrease in unemployment. Strong job figures suggest that the labor market remains in good shape and supports a smaller cut of 25 basis points.
Bank of Canada policymakers will have to decide on the size of the cut and may face the same dilemma at the next meeting in December. The current cash interest rate of 4.25% is very high and although the Bank of Canada has cut the rate by 75 basis points this year, more needs to be done to boost the economy. The key question is how aggressive the Bank of Canada is in its rate-cutting cycle, which will last until 2025.
