The rate cut this week is universally expected and we must also expect a sell-on-the-news dip

Outlook

Ahead of the Fed on Wednesday, we get the Empire State manufacturing today and Aug retail sales and industrial output tomorrow, plus Germany’s ZEW. More important would be a Supreme Court ruling on Fed Gov Cook and whether Trump can fire her, if we get that. The Court had already made a special note (and perhaps a warning) that Trump can fire nearly any federal employee but the Fed is a special case.

See the chart of the 2-year spread and the EUR/USD from Kshitij. The 2-year spread is reaching for a resistance line while the FX rate is stretching for a new high and already the highest since July 2021. In other words, the euro is outrunning the yield disadvantage.

See also the CME FedWatch probabilities. A whopping 75.3% expect rate cuts totaling 75 bp by or at the Dec 10 FOMC. (A weird 2.9% expect 100 bp in cuts.) We could get 50 bp in Sept or 25 bp in Sept but 50 bp in Oct, or any other number of combinations. (Don’t blame us for the stupidly tiny font the CME uses.)

Bottom line, a ton of uncertainty. Uncertainty about tariffs, trade deals, Russian oil, the make-up of the Fed, Trump’s reckless whims, upcoming inflation data, and the Fed’s decision-making. Uncertainty is a two-bladed knife and let’s not forget it can favor the dollar sometimes.

Forecast

The rate cut this week is universally expected and we must also expect a sell-on-the-news dip. The euro may not match-and-surpass the earlier highs and can dip back to about 1.7000, the 20-day moving average, unless the Fed surprises with 50 bp this week.

The first question is whether Mr. Powell offers any hint of forward guidance beyond the usual “data dependency.”

The second question is whether we get more cuts before year-end. The CME Fed funds betting market has a total of three cuts priced in, so presumably it depends on whether upcoming inflation readings scare the Fed.  We don’t get another PCE reading until Friday, Sept 26.

Tidbit: CNN ran a documentary on the 1980’s that reminded us that Reagan’s supply side economics was a huge, vast failure and perhaps Reagan had talked himself into it so thoroughly that he couldn’t see it. Someday there will be a documentary about Trump and his combination of supply side and tariffs as an even bigger mistake. 

Tidbit: The several employment reports of late are being taken as catastrophic and perhaps a sign of recession to come. What markets perceive tells you how they will perform, but let’s inject a little fact-checking perspective. Let’s round up and say jobs lost were 1 million. With a working age population of 212 million, according to FRED, that’s a tiny fraction. With total employment about 163.4 million, it’s still a tiny fraction. Granted, it doesn’t matter to how sentiment develops. But we should pour a spoonful of salt over the doom-and-gloom crowd.

Logically, if GDP is continuing to be firm, that must mean productivity is rising. Sure enough, the BLS for Q2 shows labor productivity up 3.3% against hours worked at up 1.1% and output up 4.4%.  (It’s less impressive on the y/y basis, productivity up 1.5%.)

Firing is not on the rise, it’s just hiring that has slowed down. Nobody knows whether this is influenced by AI, the crackdown on immigrants legal and otherwise, the shortage of skilled workers, other demographic changes, or something else not yet known.

And if growth does slow down, that is probably primarily due to tariff uncertainty, and interest rates have little or nothing to do with that. The chief effect of the coming rate cut this week is a drop in mortgage rates, otherwise mostly unaffected by tariffs (although new construction is affected big-time). Bottom line, to try to  stimulate the economy with rate cuts faces a tall brick wall of tariff uncertainty that it cannot climb. Besides, there’s that slow-moving and sticky inflation creeping up on us.

The Fed’s hundreds of economists know this perfectly well. It’s risky to cut rates. But now that expectations are so thoroughly baked in the cake, the Fed can’t do anything else. No one expects any forward guidance, but it would be nice to hear some mention of professional inflation expectations (vs. the consumer surveys, which are meaningful because of behavior fulfilling expectations but worthless as economic projections). It would add a boost to institutional credibility that we all need. In fact, we would bet an inflation forecast would be loved by the stock market, no matter what it is.

The Fed’s take has been that inflation will be a one-time shock and then the rate of change will stop rising. We doubt it, judging from the Richmond Fed company survey that showed  many companies have been delaying price increases and many intend to start raising prices well into Q1. But never mind. A specific statement, any specific statement, would be welcome… because the biggest threat to the US right now is Trump potentially taking over the Fed. It’s the bridge too far.

Note that a rise in Fed credibility is not healthy for the gold rally. But don’t exit just yet. We need to see an authentic backing off from the Trump takeover, and that’s just not realistic.

This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

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