The Australian dollar hit a two-week top on Sep 18 due to wagers that the Federal Reserve could kick-start its easing cycle with a big move, although that is far from certain and those gains could easily evaporate.

The Aussie climbed to as far as US$0.6773, the highest since Sep 3, although it is battling sellers at a key level of US$0.6767 after three sessions of gains.

The kiwi dollar rebounded 0.3 per cent to US$0.6202, having slipped 0.2 per cent overnight. Support comes in at US$0.6155 and US$0.6107, with resistance at US$0.6253 and US$0.6298.

Both have benefitted from bets the Fed could cut rates by half a point on Sep 18, with futures pricing in a chance of 64 per cent for such a move. That came despite strong retail sales data that failed to move the needle much on the size of the imminent rate cut.

“The USD may receive a small, temporary bump if the Federal Open Market Committee delivers a 25bp cut,” said Carol Kong, a currency strategist at the Commonwealth Bank of Australia (CBA). “The USD’s reaction to a larger 50bp cut will depend on the FOMC’s communication.”

“A 50bp cut that scares markets about US economic prospects could increase the USD because it is a safe haven currency. However, a 50bp cut that eases concerns about US economic prospects could undermine the USD.”

How big the Fed goes will have bearings on the interest rate path in Australia. Markets see scant prospect of a cut in the 4.35 per cent cash rate at the Reserve Bank of Australia (RBA)’s meeting on Sep 24 given policymakers have been sounding consistently hawkish.

However, analysts are tipping the monthly inflation report for August, due one day after the RBA decision, is likely to show headline inflation has slowed back to the target band of 2-3 per cent. Both CBA and Westpac expect it to come in at 2.7 per cent due to the government’s electricity rebates.

In New Zealand, data showed the current account deficit widened in the second quarter by more than expected. That prompted Goldman Sachs to lower their estimate for gross domestic product, due on Sep 19, to an annual drop of 0.5 per cent.

That compared with analyst expectations for a decline of 0.4 per cent, a reason that the Reserve Bank of New Zealand may cut aggressively and by 83 basis points by the end of the year.

Source: Straitstimes

Headline CPI inflation edged lower in August to 2.0% year-on-year (y/y), versus 2.5% y/y in July, and just below consensus expectations of 2.1% y/y.

Goods prices have fallen into deflation at -0.7% y/y, with gasoline prices down 5.1% y/y. Additionally, Statcan noted greater discounting on clothing and footwear during the back-to-school shopping period.

Services prices were up 4.3% y/y, only down one tenth from July, as Canadians continue to pay up for shelter costs. Rent prices are growing 8.9% y/y, while mortgage interest costs are growing 18.8% y/y.

The Bank of Canada’s preferred “core” inflation measures decelerated to 2.4% y/y in August, down from 2.5% y/y in July. On a three-month annualized basis, the average moved from 2.8% in July to 2.4% in August.

Key Implications

Bullseye! Headline inflation is back at the Bank of Canada’s 2.0% target. At the same time, core measures keep grinding lower. These figures would be even lower if it weren’t for the outsized impact of high housing costs. Inflation excluding shelter is growing at a paltry 0.5% y/y! This exemplifies how still high interest rates have weighed on the Canadian economy and slowed the pace of growth.

Inflation continues to validate the need for the Bank of Canada to continue cutting its policy rate. We calculate that the current policy rate is still nearly 200 basis points above where it should be based on the current state of the economy. And that is after 75 bps in cuts over the last few months. No wonder odds of larger 50 basis point cuts are growing in futures markets. Over the next few weeks, we will be getting a number of BoC members speaking on the economy. This will provide the central bank plenty of opportunity to move market pricing towards its intended path.

After more than two years of currency pain, Asia’s central banks are in for some relief as the Federal Reserve (Fed) is set to cut interest rates by a quarter-point Wednesday. The path for the region’s own monetary policy, though, will be bumpy from here.

Lower rates in the US frees up space for officials in Jakarta to Seoul and Mumbai to move lower too. The prospect for the Fed kicking off a regional cutting cycle has attracted investors, who’ve poured money into emerging Asian debt and equities, helping strengthen currencies in the region.

The question now for Asia’s central bankers is how much they need to cut in the coming months, or whether they even need to cut at all. Places such as India and the Philippines face inflationary risks, while South Korea may prioritise financial stability.

“It would be an error to think the region’s policymakers are chomping at the bit for their chance to commence monetary policy easing,” said Brian Tan, Barclays plc senior regional economist. “It’s not obvious that the economy is just crying out for policy easing and that policymakers need to shift as soon as possible.”

The wake-up call may arrive as soon as this week, with central banks in China, Taiwan and Japan all expected to hold rates, though there’s some chance of a cut in Indonesia. They’re followed by the Reserve Bank of Australia Sept 24, which is also expected to keep rates steady.

Then, in a 10-day spree mid-October, a swath of peers from India to the Philippines issue their own diverging decisions. Markets and economists are at odds on what that will look like.

Swap markets are pricing in a benchmark reduction of 50 basis points for the Reserve Bank of New Zealand on Oct 9, with some chance of easing also expected for the Reserve Bank of India on the same day.

While New Zealand is likely to cut through the rest of 2024 as the economy teeters on the edge of a third recession in two years, analysts see a different picture playing out for the rest of the region.

Inflationary pressures in India and the Philippines are likely to keep policymakers there more cautious, with analysts forecasting only one 25 basis point cut in the fourth quarter, surveys show. Bangko Sentral ng Pilipinas Governor Eli Remolona signaled a quarter-point cut in October or December.

Economists also see only one cut in the final three months of the year from the central bank in South Korea, where officials are keeping tabs on financial imbalances associated with home prices and household loans.

Economists expect the central bank to cut its key rate as soon as it sees signs that the property market is cooling, particularly in Seoul. In Taiwan, as well, real estate market trouble is likely to make officials wary of cutting rates.

The Bank of Thailand will perhaps be the longest holdout, with expectations that the conservative institution will resist government calls to cut until next year at the earliest.

“Now, central banks are able to focus more on the domestic idiosyncrasies when they are contemplating their monetary policy action,” said Khoon Gho, head of Asia research at Australia and New Zealand Banking Group. “For the last two years or so, when the Fed was hiking aggressively, central banks here were really responding to that pressure on their currencies.”

Two factors may change the picture: A US recession that would strengthen the greenback in a flight to safety or a November presidential election outcome that heralds protectionist policies, hurting trade-reliant countries in the region.

The former isn’t the base case for economists, and the latter isn’t likely to halt the flow of funds into Asia assets just yet.

If Fed Chair Jerome Powell and his colleagues reduce interest rates and signal more cuts are in the offing, that “will keep the party going and we’ll see more money coming to Asia”, said Taimur Baig, chief economist at DBS Group Holdings. “Investors have voted with their feet” for a shallow easing cycle in Asia, he said.

Source: Theedgemarkets

Bridgewater Associates founder Ray Dalio said the overall picture of the economy probably warrants a smaller interest-rate cut by the US Federal Reserve (Fed) this week.

“The Fed has to keep interest rates high enough to satisfy the creditors that they are going to get a real return without having them so high that the debtors have a problem,” Dalio said in an interview on Bloomberg Television in Singapore on Wednesday.

“Whether it’s 25 or 50 basis points, 25 basis points would be the right thing to do if you look at the whole picture,” Dalio said on the sidelines of the Milken Institute Asia Summit 2024. “If you look at the mortgage situation, which is worse and that affects more people, then it’s probably 50 basis points.”

The Fed is widely expected to lower interest rates later Wednesday after holding borrowing costs at a two-decade high for more than a year. Investors and forecasters are split over whether it will cut by a quarter percentage point or a bigger, half-point move.

But Dalio said that ultimately what the Fed does this week “doesn’t make a difference” over the longer term. Policymakers will need to keep real interest rates low to enable the servicing of mounting debts, he said.

Source: Theedgemarkets

Oil prices steadied on Wednesday, after rising in the previous two sessions, as investors await the US Federal Reserve's (Fed) anticipated interest rate cut, with the potential for more violence in the Middle East supporting the market.

Both contracts gained by about US$1 a barrel on Tuesday on lingering supply disruptions in the US, the world's biggest oil producer, after Hurricane Francine and as traders bet that demand may increase following what would be the Fed's first interest rate cuts in four years.

Prices were also supported by the potential for more violence in the Middle East that may cause possible output disruptions in the key producing region after Israel allegedly attacked militant group Hezbollah with explosive-laden pagers in Lebanon.

"Markets have calmed down as concerns over hurricane damage and escalating tensions in the Middle East have been factored in," said Mitsuru Muraishi, an analyst at Fujitomi Securities.

"Now, investors are focusing on the Fed's rate cuts which could revitalise US fuel demand and weaken the dollar," he said, predicting that oil prices are likely to maintain a bullish tone after Brent hit its lowest since 2021 last week.

Traders kept bets the Fed will start an expected series of interest rate cuts with a half-percentage-point move downward on Wednesday, an expectation that may itself put pressure on central bankers to deliver just that.

Hezbollah promised to retaliate against Israel after the pagers detonated across Lebanon on Tuesday, killing at least eight people and wounding nearly 3,000 others, including fighters and Iran's envoy to Beirut. Israel declined to comment on the detonations.

The market also found support from the expectation of US oil purchases for the Strategic Petroleum Reserve (SPR).

The Biden administration will seek up to six million barrels of oil for the SPR, a source familiar with issue said on Tuesday, a purchase that if completed will match its largest yet in the replenishment of the stash after a historic sale in 2022.

US oil inventory data released on Tuesday from the American Petroleum Institute (API) was mixed. Oil stockpiles rose by 1.96 million barrels in the week ended Sept 13, according to market sources citing the API figures, but gasoline and distillate stocks both rose by about 2.3 million barrels.

Analysts polled by Reuters estimated on average that crude inventories fell by about 500,000 barrels last week. The US Energy Information Administration's report is due on Wednesday at 10.30am EDT (1430 GMT).

Source: Theedgemarkets

Uncertainty over the size of an initial interest rate cut expected Wednesday from the Federal Reserve has sparked a related debate over the possibility of an accelerated halt to the central bank’s balance sheet drawdown.

Prospects for an opening cut of half a percentage point have been gaining ground over a smaller quarter-point reduction in rate futures markets, and if policymakers do go for the larger option and signal worry about the economic outlook, the runway for more quantitative tightening, or QT, could get much shorter.

QT is largely seen as a liquidity management tool and distinct from Fed interest rate policy focused on quelling inflation without inflicting too much pain on the labor market. But more aggressive interest rate cuts from the Fed might be seen at odds with tighter liquidity, depending on the reasons behind the rate cuts.

An imminent shuttering of QT would represent a major shift in the outlook for the central bank balance sheet. A survey of major banks from the New York Fed in July found firms predicting QT’s end in April of next year, as Fed officials have signaled they saw ample room to continue it.

“If they ease rates by 50 basis points, I think the decision about the balance sheet becomes more complex,” said Patricia Zobel, former manager of the New York Fed’s group that implements monetary policy and now head of macroeconomic research and market strategy at Guggenheim Investments.

“We do have some chance” of an earlier QT end if a larger cut is accompanied by concerns about the economy, Zobel said. For now, the former Fed official is anticipating a quarter-point cut and QT continuing on its current trajectory.

The Fed currently targets the fed funds rate in a 5.25% to 5.50% range.

Matthew Luzzetti, economist at Deutsche Bank, said a big rate cut joined with hints of more aggressive easing in the updated policymaker projections due on Wednesday as well would mean “there would be a conflict between reducing rates and continuing to run down the balance sheet, and they might not want that kind of mixed signal about their policy tools in that environment.”

Bank of America analysts, meanwhile, agreed a half-point cut aimed at propping up the economy would bring a halt to QT relatively soon.

The heightened rate-cut uncertainty comes down to gauging whether the Fed will be lowering borrowing costs simply to normalize them given abating inflation, and some reckon a big reduction or two could still fit along that path. But the more salient risk to the QT outlook is if interest rate policy adjusts because of rising worries about the job market hitting stall speed.

LIQUIDITY STILL FLUSH

The clouded outlook for the balance sheet comes after the QT process just crossed the two-year mark. The Fed more than doubled the size of its holdings by the summer of 2022 via purchases of Treasury bonds and mortgage-backed securities, topping out at holdings of $9 trillion. The buying was aimed at smoothing unsettled markets and providing a lift for the economy beyond near-zero percent interest rates as the COVID-19 pandemic raged.

A visualization of the evolution of Fed holdings

The QT process kicked off as the Fed shifted to rate increases to quell inflation and officials decided excessive accommodation was no longer appropriate. The drawdown has clipped about $1.8 trillion from Fed holdings so far, and in May the Fed slowed what had been a targeted monthly drawdown of $95 billion to its current limit of $60 billion.

The Fed seeks to have enough liquidity in the financial system to allow for normal short-term rate volatility and firm control over the fed funds rate. So far, discussion around ending QT has largely centered around finding that sweet spot for liquidity.

QT "is not going to be adjusted until the Fed thinks that they've made the transition from abundant reserves to ample reserves," said William Dudley, who led the New York Fed until his retirement in 2018. "They don't know exactly where, when that's going to occur, but they are pretty confident they haven't gotten there yet," he said.

So far, QT has run squarely in the background. It has faded as a market mover because investors have already "built in" QT into longer-term borrowing costs, New York Fed President John Williams said.

Meanwhile, former St. Louis Fed leader James Bullard, now dean of Purdue University's business school, noted that at least for now, QT and interest rate policy are aligned and can remain so even with rate cuts.

"Even if you lower the policy rate somewhat, it will still be above everyone's estimate of neutral, so you'd still be running a restrictive monetary policy with respect to the policy rate, and that complements the quantitative tightening part of the policy," Bullard said.

When the funds rate gets to around neutral, Bullard said that would be time to consider ending QT to better align the two policy tools. Analysts at research firm LH Meyer said any move to a fed funds rate of 3% or lower would be by itself a trigger for ending QT.

Source: Theedgemarkets