FX Daily Strategy: APAC, September 18th

FOMC the main focus on Wednesday

Market sees 50bp hike as most likely so scope for USD gains on a 25bp cut

GBP risks on the downside on UK CPI

Most of the focus on a busy Wednesday will be on the FOMC decision. According to Nick Timiraos, the WSJ journo widely seen as the Fed mouthpiece “The Fed faces a finely balanced set of considerations over whether to cut by 25 or 50 basis points…The case for 50 comes down to what Fed officials call risk management but what might be thought of as regret minimization. If you cut 50 here and you think the Fed will need to cut again after that, you are unlikely to regret such a cut even if the economy chugs along between now and your next meeting. But if you cut 25 and things worsen a lot in the coming weeks, you'll feel bigger regret as you'll be behind the curve. The case for 25 boils down to some combination of 1) process issues (i.e., 50 will signal something more urgent; there's an election soon; communications were not explicit enough about 50 in the run-up to this meeting), 2) a view that the economy is doing just fine and will continue to do so with more gradual reductions, and 3) that because financial conditions are easy (in part because markets expect the Fed to deliver a string of cuts), igniting risk assets could make it harder to finish the inflation fight.”

The tone of this sounds as if 50 should be favoured, and the market is priced for a 65% chance of a 50bp cut. The reaction would therefore be greater to a 25bp cut, even if the impact is moderated by comparatively dovish comments from Fed chair Powell.  The USD has been weakening through the last week as the market has moved towards pricing in a 50bp cut, although it did manage a modest rally on Tuesday in the wake of stronger than expected retail sales and industrial production data. We see the call as a close one between 25bps and 50bps, but the press reports aren’t enough to persuade us to change our call from 25bps. This suggests we will see a USD rally on the news. A 25bp cut will also be seen as disappointing for risk assets. Initially, expect USD gains to be fairly even across the board, but if equities prove resilient to higher yields, the JPY should be expected to suffer more. However the message of the reports is that the slightly disappointing August CPI does not exclude a 50bps move, and that whichever option the Fed does choose for September, markets should not assume a string of moves of equal magnitude. Bigger picture, we still expect the USD to soften over the course of the year, with the JPY likely to be the biggest beneficiary.

UK CPI forecasts

Before the FOMC there is important August CPI data for the UK, which is the last significant data ahead of the BoE rate decision on Thursday. As it stands, the market is pricing in only around a 35% chance of a 25bp BoE rate cut on Thursday, but these odds could be affected by the CPI data and by the FOMC decision. We see definite downside risks for CPI relative to consensus. The consensus is for headline to hold at 2.2% and core to rise to 3.5% while we see decline to 2.1% and 32% respectively. This could certainly be expected to increase the risk of a BoE cut, with the probability likely rising to more than 50% if our forecasts are correct.  Even if the data is in line with consensus, a 50bp cut from the Fed might well increase market expectations of the BoE cutting on Thursday, so we see some downside risks for GBP. EUR/GBP in any case looks well supported near 0.84, so risks should be on the upside.