Fed Hawks Challenge Easing Expectations
The US Dollar continues to attract demand as markets reassess the likelihood of a Federal Reserve rate cut to the 3.00–3.25% range in December. Supporting the Dollar further are tightening conditions in US money markets, driven by the Treasury’s efforts to rebuild its cash reserves. With limited official data releases this week, investor attention shifts to private-sector labor reports for insight into the health of the US job market.
Two key factors are currently supporting the Dollar’s resilience:
Recalibration of Fed Rate Expectations Following last week’s press conference by the Chair of the Federal Reserve, the probability of a 25 basis point rate cut in December has dropped to 66%. This could decline further depending on upcoming labor data. Today’s ISM Manufacturing Index includes an employment component, while Wednesday’s ADP jobs report is expected to be the week’s most influential release. Diverging views among Fed officials have added to the uncertainty. On Friday, two incoming FOMC members stated they would have opposed last week’s rate cut had they been eligible to vote.
Tightening Liquidity in US Money Markets The Federal Reserve’s quantitative tightening has reduced bank reserves, while the Treasury has increased its General Account from $300 billion to $950 billion. This shift from surplus liquidity to tighter conditions was evident in Friday’s data, showing banks borrowed $50 billion overnight from the Fed’s Standing Repo Facility at a rate of 4.00%—above the midpoint of the Fed’s 3.75–4.00% target range. Such tight conditions typically support the Dollar and may extend globally via cross-currency basis swaps, especially if banks begin exchanging euros for Dollar funding. While this could pressure EUR/USD lower, no signs of such stress have emerged yet.
EUR/USD traded volatility has dropped below 6%, nearing the summer 2024 lows of 5.30%. The three-month risk reversal has also flattened, indicating diminished bullish sentiment for the Euro. Market consensus sees EUR/USD at 1.18 by year-end, though ING analysts suggest a slightly stronger rally is possible if the Fed adopts a more dovish stance. However, ECB commentary this week is unlikely to provide meaningful support. The debate within the eurozone leans toward undershooting inflation and potential further rate cuts.
Analysts expect EUR/USD to find support near 1.1500 this week, contingent on softer US labor data.
Markets are increasingly pricing in a Bank of England rate cut as early as Thursday. From just a 6% probability at the start of October, expectations have surged to 29%. Some major investment firms have revised their forecasts to anticipate a move this week. ING’s UK economist believes the central bank may wait for the Autumn Budget before acting. With the terminal rate already priced at 3.25% for next summer, further downside for the Pound may be limited. EUR/GBP could dip slightly if the Bank retains its hawkish tone, with buying interest expected near the 0.8730–0.8750 range.
In Central and Eastern Europe, fresh data releases are expected to shape local monetary policy outlooks.
Poland: The central bank may cut rates by 25 basis points to 4.25% following a surprise drop in inflation.
Czech Republic: The CNB is likely to hold rates steady at 3.50%, with attention on its updated forecast and guidance.
Hungary: Key economic indicators will be released later this week.
On the political front, the Czech Republic’s new government is set to sign a coalition agreement today, with leaked details suggesting short-term anti-inflation measures and a stable fiscal deficit. On Friday, Prime Minister Viktor Orban will meet with the President of the United States in Hungary, potentially discussing energy imports and strategic cooperation.