Fed cuts interest rates by 50 basis points?

According to the CME Fed Watch Tool, the probability that the Federal Reserve (Fed) will cut interest rates by 50 basis points instead of 25 basis points on Wednesday evening is currently 59%. A week ago it was 30%. The US dollar is reacting to this with strong declines – because the prospect of lower interest rates is making the dollar area less attractive for investors!

The dollar fell to its cheapest level since January. Bloomberg's U.S. currency indicator is down 0.3% today, approaching the August low, which a break through would have dropped it to its lowest level since January. The dollar's decline is boosting major currencies such as the yen, which is rising to its highest level since July 2023.

After weeks of debate over whether the Fed will begin its monetary easing with a 25 or 50 basis point cut, traders are favoring the latter option. Futures prices tied to the Fed's decision this week have about a 58% probability of a half-point cut, compared to a coin toss on Friday late last week.

“We see a new and imminent Fed easing cycle as a major headwind for the dollar,” said Rodrigo Catril, strategist at National Australia Bank Ltd. “The dollar will experience a cyclical coincidence if the Fed eases next year and moves toward neutral, if not below.”

The dollar has lost value against most major currencies over the past month, with once-beaten currencies such as the yen and Swiss franc among the biggest gainers against the greenback. Japan's currency is gaining again today, breaking above the closely watched 140 per dollar mark as investors bet on a narrowing interest rate differential between the two nations.

With Federal Reserve members on hold ahead of the Sept. 17-18 monetary policy meeting, traders can lean on a few data points, including August retail sales on Tuesday, to gauge the Fed's thinking. One technical indicator is signaling support for the dollar as momentum is bearish.

“While the Fed's easing cycle is at risk of being brought forward, we believe the market is overpricing this risk and the Fed will cut rates by 25 basis points this week, which would boost the dollar,” said David Forrester, strategist at Credit Agricole CIB in Singapore.

Still, the market is overwhelmingly in favor of a weaker U.S. currency. The euro, yen, Canadian and Australian dollars are all expected to gain against the dollar by this time next year, according to Bloomberg surveys of analysts.

“An unexpectedly dovish Fed could weaken the dollar,” wrote Bob Savage, head of market strategy and insights at BNY, in a note. This could “change inflation forecasts for nations like the UK that import commodities at dollar prices and prompt Norges Bank to support the oil-linked krona,” he wrote.

FMW/Bloomberg

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