- Ahead of next week’s FOMC meeting and in the wake of this week’s US inflation data and the ECB’s decision to reduce rates 25bp, it is worth recapping what the Fed and the SARB are faced with and where the risks to the prevailing market expectations lie.
- While inflation has moderated and central banks stand ready to reduce rates, market investors must gauge whether what has been priced in is realistic. Any significant deviation from expectations can cause volatility in financial markets and currencies and must be carefully monitored.
- All signs point to the Fed being justified in reducing rates back towards its neutral rate, which, according to the Fed’s own studies, hovers around 200bp lower than the current Fed funds rate. The implication is that the Fed will still be restrictive for the first 150bp worth of rate cuts before it approaches neutral, and the trajectory of cuts will depend on just how significant this slowdown turns out to be.
- The market feels that 250bp worth of rate cuts are required to pre-emptively prevent a hard landing, with some of that front-loaded. Therefore, any US data that beat expectations will translate into a rise in rates and support the USD.
BASELINE VIEW:
The baseline view is that the Fed is on track to engineer a soft landing. If accurate, the Fed will reduce interest rates more rapidly than other central banks to erode US bond yield attraction while at the same time supporting risk appetite. This scenario would likely be constructive for the ZAR and help it extend its appreciation.
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