Bessent Blasts Fed Renovation And Suggests 50 Bps Rate Cut As U.S. Pushes For Major Trade Deals

If the Federal Reserve were to significantly shrink its balance sheet, would that enable policymakers to cut interest rates significantly? The argument made by former Fed Governor Kevin Warsh, who is a candidate to replace Jerome Powell as chair of the Fed, and some others is that such a move would reduce the amount of liquidity in the financial system. As a result, financial conditions would tighten and the Fed would respond by lowering short-term rates. In Warsh’s telling, households and small businesses would benefit from lower short-term rates and financial markets would become less exuberant and overheated.

Although sounding plausible enough — a smaller balance sheet would lead to lower short-term rates - it’s mostly a fairy tale.

First, the effect of a smaller balance sheet on financial conditions is likely to be small. As a result, the offsetting reduction in short-term rates will also be modest. Just consider the past three years. The Fed has trimmed its balance-sheet assets via quantitative tightening by almost 25% from a peak of about $8.97 trillion in 2022 to $6.64 trillion, yet financial conditions remain quite loose even though policymakers judge short-term rates to be at least modestly restrictive.

Shrinking the balance sheet has had only a modest impact on financial conditions because quantitative easing has proven to be not very powerful in providing stimulus to the economy. The reserves created by quantitative easing just accumulate on the Fed’s balance sheet. When the Fed buys US Treasury and related securities, the sellers deposit the funds back into the banking system. Banks, in turn, take these funds and hold them at the Fed in the form of central bank reserves. When the smoke has cleared, the Fed holds more Treasury securities and banks have more deposits and more reserves at the Fed. And by extension, households and businesses have more bank deposits and less long-term fixed-income assets.

If the increase in reserves at the Fed led to more lending and rapid credit growth, then a reversal would have a large effect. But this isn’t how monetary policy works these days. Credit growth is determined mainly by the interest rate the Fed sets on reserves. That is the risk-free rate for banks that establishes a floor for other short-term rates. The outlook for short-term rates in the future, in turn, drive bond yields. Credit growth depends on the price of credit, not the quantity of reserves. The size of the money supply doesn’t drive credit creation, but rather the level of interest rates. The shift to paying interest on reserves at the Fed that began in 2008 has cut the linkage between balance sheet size, money supply and economic activity.

The second issue is that shrinking the Fed’s balance sheet much further while maintaining control of monetary policy would not be a trivial exercise. If the Fed were to trim significantly from here, the supply of reserves would become scarce relative to banks’ demand for reserves to satisfy their liquidity requirements and execute customer payments. Recall that when the supply of reserves inadvertently dipped below bank demand in September 2019, money market rates rose sharply. The Fed had to scramble and quickly add reserves to push rates back down toward its target. In response, the Fed established a standing repo facility that banks could tap if they needed more reserves. This was designed to put a cap on short-term interest rates if reserves were ever to become scarce.

If the Fed were to continue quantitative tightening and run down its securities holdings it would eventually have two options. It could offset the balance sheet shrinkage from the securities run-off by adding reserves through open-market operations — for example, financing the Treasury holdings of the primary dealers by engaging in repo operations. In this case, the Fed’s balance sheet would stop shrinking. Instead, it would hold fewer Treasury and related securities but would have a much bigger footprint financing Treasury securities.

Or it could abandon its current ample reserves regime framework and return to the scarce reserves regime that was in place prior tothe 2008 TARP legislation. This would require major changes in how the Fed conducts monetary policy, including presumably changing how it compensates banks for the reserves they hold at the central bank.

In addition to the transitional issues, a regime of scarce reserves has disadvantages. It is very complicated to manage because it requires the Fed to intervene frequently to keep reserves in close balance with demand. For example, in the past, the Treasury had to keep its cash balance at the Fed low and stable so that fluctuations did not make it difficult for the central bank to maintain control of short-term interest rates. Banks satisfied reserve requirements over a two-week reserve maintenance period to make it easier for the Fed to match demand and supply.

Also, scarce reserves are incompatible with open-ended backstop facilities that can support confidence during times of stress. In an open-ended backstop, there is no risk that the central bank will exhaust its lending capacity. In contrast, when the amount of funds on offer is limited, there is an incentive to access the facility quickly before the funds run out. An open-ended facility is superior in maintaining and restoring confidence in the system. In contrast, a scarce reserves regime undermines the ability of the central bank to fulfil its lender of last resort function — the reason why the Fed was established in the first place.

If the Fed were to shrink its balance sheet sharply, the outcome would not be a sharp drop in short-term interest rates and a booming economy. Instead, the execution of monetary policy would be impaired and the Fed would lose the flexibility to be able to respond aggressively during times of economic stress and financial instability.

Source: Bloomberg Europe

Across equity, bond and currency markets, gauges of volatility are slumping to their lowest levels of the year.

The Cboe Volatility Index, which measures the expected 30-day volatility for the S&P 500 — and dubbed Wall Street’s fear gauge — just fell to its lowest since December. A similar index for global currencies is the weakest in a year, while a gauge for US Treasuries is at levels last seen in early 2022.

It might seem jarring that markets are pricing a limited chance of swings given a backdrop that’s littered with risk, from geopolitical tensions and sticky inflation to US President Donald Trump’s threats to the Federal Reserve’s independence. But dig a little deeper, and the moves start to stack up.

For starters, there’s “a lot of cash sitting on the sidelines,” said Mohit Kumar, chief economist at Jefferies International. That means plenty of investors are ready to snap up assets at lower prices, damping any selloffs before they really get going.

Then there’s the global economy, which seems far from sinking into the recession that many feared was inevitable when Trump moved to reshape global trade in April, triggering weeks of wild price swings.

Indeed, the US President has walked back from his most extreme tariffs threats, stoking investor confidence that he will ultimately always relent after aggressive posturing. That strategy — which analysts and strategists call “TACO” for “Trump Always Chickens Out” — mean investors have stepped in for fear of missing out on a rally.

Investors “realize that they’re watching the market go up,” said Guy Miller, chief market strategist and head of macroeconomics at Zurich. “There are still a lot of risks out there, but they feel they have to participate in this.”

To be sure, markets have seen bouts of turbulence this month. The VIX reached nearly 22 points intra-day on worse-than-expected payrolls data and tariffs, but it’s already displaying the pattern that options traders are accustomed to – fast reversal to lower levels.

The latest retreat this week came as the S&P 500 notched a fresh record high on Tuesday afternoon, with soothing inflation data boosting bets for a Fed interest-rate cut. In contrast to earlier this year, when even one cut was in doubt, money markets are now fully pricing two-quarter point reductions and a chance of a third by year-end.

Still, others have sounded an alarm over potential complacency. In Trump’s first term, the Vix Index slid below 10 to a record low in late 2017, before spiking to hit 50 the following year.

Salman Ahmed, global head of macro and strategic asset allocation at Fidelity International, warns that investors must be prepared as markets enter a “phase of potential disruption.” The firm puts the chance of a US-led cyclical recession at 20% as the impact of higher tariffs seeps through the economy.

Meanwhile, Washington’s rising debt burden and spending levels may also force the Fed to adopt unusual measures such as yield curve control, he added. That would likely send tremors through the US Treasury market as bond prices become distorted.

“The US is entering a phase of fiscal dominance, where government spending programmes increasingly overshadow monetary policy,” Ahmed said. “How the Fed responds in this environment will be critical for market stability.”

Source: Bloomberg Europe

Commodity currencies are those tied to the value of a country’s key exports, such as oil, metals, or agricultural goods. Their movements are influenced by shifts in global demand, supply disruptions, and economic policies. In this article, we will explore how commodity prices impact commodity-linked currencies and what traders may need to consider.

What Is a Commodity Currency?

The commodity currency definition refers to currencies issued by countries whose economies rely heavily on exporting natural resources. Their value tends to fluctuate in line with the prices of key commodities like oil, metals, and agricultural goods. When these exports become more valuable, the national economy benefits, often leading to a stronger currency. Conversely, when commodity prices fall, these currencies tend to weaken due to declining export revenues. Several well-known commodity-based currencies fall into this category.

Canadian Dollar (CAD) – Oil and Trade with the US

Canada is one of the world’s largest crude oil exporters, making CAD highly sensitive to oil price fluctuations. A rise in oil prices typically strengthens CAD, as higher revenues improve Canada’s trade balance and economic outlook. CAD also reacts to US economic performance, given that over 75% of Canadian exports go to the US. If US demand weakens, CAD can struggle even if oil prices move in a narrow range.

Australian Dollar (AUD) – Iron Ore, Coal, and China’s Economy

Australia is a major supplier of iron ore and coal, with China as its biggest buyer. AUD often moves in response to Chinese industrial activity and infrastructure investment. If China’s economy slows, reduced demand for raw materials can weigh on AUD. Interest rate decisions from the Reserve Bank of Australia (RBA) also play a role, particularly when rates diverge from global peers.

New Zealand Dollar (NZD) – Dairy and Agricultural Exports

New Zealand is the world’s largest dairy exporter, with milk products accounting for a significant portion of its trade. NZD tends to strengthen when global dairy prices rise, especially when demand from Asia is strong. However, because New Zealand has a smaller, more trade-dependent economy than Australia, NZD is also influenced by broader market sentiment and risk appetite.

Norwegian Krone (NOK) – Oil and Energy Markets

Like CAD, NOK moves with oil prices, but its sensitivity is heightened by Norway’s reliance on offshore oil production. Shifts in European energy policy, such as demand for alternative fuels, can also impact NOK beyond direct oil price movements.

Brazilian Real (BRL) – Agriculture and Metals

BRL is driven by Brazil’s exports of petroleum oils, iron ore, soybeans, and other agricultural products. Political stability and investor confidence in emerging markets also affect BRL, making it more volatile than some other commodity currencies.

Key Drivers of Commodity Prices

Commodities fluctuate based on a range of global economic forces, from supply and demand dynamics to geopolitical shifts and financial market activity. Understanding these factors may help traders analyse price trends and their potential impact on commodity-linked currencies.

1. Global Supply and Demand

The fundamental driver of commodity prices is the balance between production and consumption. When supply is tight due to poor harvests, mining disruptions, or oil production cuts, prices tend to rise. Conversely, oversupply—such as when oil producers flood the market—can push prices lower.

2. Economic Growth and Industrial Activity

The demand for commodities is closely tied to economic expansion. Rapid industrial growth increases demand for raw materials like iron ore, copper, and oil. China, for example, is the world’s largest commodity consumer, meaning its economic cycles have a major impact on global prices. A slowdown in Chinese manufacturing can weaken demand, driving commodities and related currencies lower.

3. Geopolitical Risks and Trade Policies

Wars, sanctions, and trade agreements can disrupt supply chains, affecting commodity availability and prices. Sanctions on oil-producing nations or conflicts in key mining regions can tighten supply, driving prices higher. On the other hand, trade agreements that reduce tariffs can boost commodity exports, influencing prices.

4. Central Bank Policy and Inflation

Higher inflation often pushes commodity prices up, as investors turn to raw materials as a hedge against currency devaluation. Central banks responding with interest rate hikes can curb inflation but may also reduce economic activity, lowering commodity demand.

5. Speculation and Market Sentiment

Commodities are heavily traded in futures markets, where speculative activity can cause price swings. Traders believing in higher future demand can drive up prices, while negative sentiment—such as recession fears—can lead to sell-offs.

How Commodity Prices Influence Commodity Currencies

Commodity currencies don’t just track export price movements—they react to broader economic shifts. Here’s how changes in commodity prices correlate with these currencies:

1. Trade Balance and Export Revenues

When commodity prices rise, exporting nations see higher revenues, improving their trade balance and strengthening their currency. Foreign buyers need to exchange their currency for AUD, CAD, or NOK to purchase commodities, increasing demand. When prices fall, the reverse happens, weakening a commodity currency.

2. Economic Growth and Investment

Higher commodity prices often stimulate economic growth in resource-rich countries, leading to increased business investment and job creation. This can improve confidence in the currency. However, if rising prices contribute to inflation, central banks may intervene, affecting currency performance.

3. Interest Rates and Inflation Control

If commodity price increases drive inflation, central banks may consider raising interest rates to stabilise the economy. These higher interest rates tend to attract investors and create buying pressure in the currency. However, if commodity prices drop sharply, central banks may lower rates to support economic growth, putting downward pressure on the currency.

4. Risk Sentiment and Capital Flows

Commodity currencies are often tied to investor risk appetite. In strong market conditions, investors seek higher yields and favour currencies like AUD, NZD, and CAD. But in times of uncertainty—such as economic downturns or geopolitical crises—investors typically move into so-called safe-haven assets, causing commodity currencies to weaken.

5. Global Supply Chain Disruptions

Natural disasters, political instability, or trade restrictions can disrupt commodity supplies. If this leads to higher commodity prices, it often strengthens commodity currencies. However, if demand falls due to economic downturns, both commodity prices and related currencies can suffer.

Implications for Traders

Understanding how commodity prices affect currencies provides traders with insights into market dynamics. For example, traders regularly track oil price reports, iron ore demand forecasts, or global agricultural market updates.

Because commodity currencies often reflect underlying shifts in global economics, traders frequently monitor economic indicators. Economic indicators from major commodity-importing nations—like China’s manufacturing data—are particularly influential, as they provide clues about future demand trends.

Additionally, commodity-linked currencies often respond strongly to shifts in risk appetite. Traders recognise that positive market sentiment typically lifts these currencies, while concerns about global growth or market instability can trigger weakness. This relationship helps traders assess broader market conditions, including when investors might favour riskier or so-called safer assets.

Interest rate differentials between commodity-exporting countries and other major economies are also closely observed. Traders believe that rising interest rates may attract capital inflows and support currency appreciation, especially if commodity prices remain firm.

The Bottom Line

Commodity currencies are closely tied to global economic trends, supply and demand shifts, and market sentiment. Awareness of these relationships may support traders in creating their forex and commodity trading strategies Monitoring commodity markets, interest rate decisions, and geopolitical events may be helpful when navigating commodity currencies.

FAQ

What Are Commodity Currency Pairs?

Commodity currency pairs consist of a commodity-linked currency traded against another currency, typically a major one like the US dollar. Examples include USD/CAD, AUD/USD, and NZD/USD, where CAD, AUD, and NZD are influenced by commodity prices.

What Is Forex and Commodity Trading?

Forex trading involves exchanging currencies, while commodity trading focuses on raw materials like oil, metals, and agricultural products. Since some currencies are tied to commodities, both markets often move together.

What Is the Most Traded Commodity Currency Pair in Forex?

USD/CAD is known as one of the most traded commodity currency pairs. Canada’s reliance on oil exports makes CAD highly responsive to crude oil prices, resulting in notable currency correlations with oil market movements.

Source: FXOpen

China’s credit expansion rebounded less than expected in July from a year ago with a key loan gauge falling to the lowest since 2007, despite the boost from a surge in government bond sales.

Banks are usually in no rush to meet their quarterly loan targets in July, putting the brakes on financing activity. A year ago, bank credit to the real economy contracted for the first time since 2005, as domestic demand slumped with the economy caught in a deflationary cycle.

Policymakers aren’t close to injecting more stimulus any time soon, given China’s solid economic growth in the first half of this year. Analysts generally expect the PBOC to roll out monetary easing in the fourth quarter, following cuts to interest rates and banks’ reserve requirement ratio in May.

Despite brisk growth in real terms, the economy is suffering from increasingly entrenched deflation that depresses borrowing demand.

Nominal gross domestic product, which accounts for price changes, grew in the second quarter at the weakest pace outside the pandemic since data series began in 1993.

Top leaders have turned their attention to putting an end to deflationary price wars in recent weeks, but a lack of concrete plans means a meaningful rebound is unlikely any time soon.

Source: Bloomberg Europe

Hedge Funds Rebuild Japan Exposure After July Pullback

Tech and Industrials Lead the Upside Momentum

Source: Reuters

The cryptocurrency market is currently witnessing a significant development that could excite Ethereum holders. Recent on-chain data indicates a remarkable trend: substantial Ethereum outflows from centralized exchanges. This movement signals growing investor confidence and points towards potential upward price momentum for the asset.

Decoding Ethereum Outflows and ETH Buying Pressure

Understanding the flow of cryptocurrencies onto and off exchanges offers crucial insights into prevailing market sentiment. When a significant amount of a digital asset, such as Ethereum, moves off exchanges, it often suggests that holders intend to retain it for the long term, rather than sell it immediately. This reduction in the readily available supply on exchanges creates a powerful dynamic: increased ETH buying pressure.

According to insights from CryptoQuant contributor Burakkesmeci, Ethereum’s 30-day netflow average has recently plunged to negative 40,000 ETH. This specific metric measures the net amount of ETH entering or leaving exchanges. A consistently negative figure, particularly one of this magnitude, directly signifies sustained exchange outflows. Essentially, more Ethereum is leaving exchanges than entering them, effectively removing supply from immediate sale and strengthening the bullish case.

How Spot ETF Demand Amplifies the Ethereum Price Rally?

The current trend of significant Ethereum outflows is not an isolated event. It converges with another major catalyst that could significantly impact the market: the growing anticipation and eventual reality of spot Ethereum Exchange-Traded Funds (ETFs). The potential approval of these ETFs in major markets, especially the United States, introduces a new, substantial source of institutional demand.

• Increased Accessibility: Spot ETFs allow traditional investors to gain exposure to Ethereum without the complexities of directly holding the cryptocurrency. This broadens the investor base considerably.
• Institutional Inflow: Large institutional investors often prefer regulated investment vehicles like ETFs. Their participation can channel massive capital into the Ethereum ecosystem.
• Reduced Supply on Exchanges: As institutions or ETF issuers accumulate ETH to back their funds, they typically withdraw it from exchanges. This action further contributes to the negative netflow, reinforcing the ETH buying pressure and supporting a sustained Ethereum price rally.

Navigating the Crypto Exchange Data Landscape: What to Watch?

For investors and enthusiasts tracking the market, understanding key on-chain metrics is vital. Crypto exchange data provides a level of transparency into supply and demand dynamics that traditional markets often lack. Monitoring metrics like netflow can offer actionable insights into market direction.

• Netflow Direction: A consistently negative netflow, as observed with current Ethereum outflows, points to accumulation. Conversely, large inflows could signal potential selling pressure.
• Volume Trends: Observe the trading volume accompanying these outflows. Higher volumes with a negative netflow indicate stronger conviction among buyers.
• Whale Activity: Keep an eye on large transactions. Significant withdrawals by large holders, often called ‘whales,’ can sometimes precede substantial price movements.

While the current data paints a largely positive picture for Ethereum’s short-term prospects, the crypto market remains dynamic. External factors, broader market sentiment, and regulatory developments can always influence trends. However, the fundamental signal from these strong Ethereum outflows provides a solid foundation for optimism and reinforces the potential for a continued Ethereum price rally.

In summary, the substantial Ethereum outflows from exchanges, coupled with the looming prospect of spot Ethereum ETFs, present a compelling case for a continued Ethereum price rally. This robust ETH buying pressure, clearly evidenced by the negative netflow, underscores a period of strong accumulation. As more Ethereum moves off exchanges and into long-term holdings or institutional vehicles, the available supply shrinks, naturally driving up demand and price. Keep a close watch on these key indicators as Ethereum navigates its exciting trajectory.

Source: CryptoSlate