Oil Prices Steady, With Investors Focusing on Fed Decision

The United Kingdom (UK) Office for National Statistics (ONS) will release August Consumer Price Index (CPI) figures on Wednesday. Inflation, as measured by the CPI, is one of the main factors on which the Bank of England (BoE) bases its monetary policy decision, meaning the data is considered a major mover of the Pound Sterling (GBP). 

The BoE met in August and decided to trim the benchmark interest rate by 25 basis points (bps) to 5%, a decision supported by a slim majority of 5 out of the 9 voting members of the Monetary Policy Committee (MPC). The widely anticipated announcement had a negative impact on the GBP, which entered a selling spiral against the US Dollar, resulting in the GBP/USD pair bottoming at 1.2664 a couple of days after the event.

What to expect from the next UK inflation report?

The UK CPI is expected to have risen at an annual pace of 2.2% in August, matching the July print. The core annual reading is foreseen at 3.5%, higher than the previous 3.3%. Finally, the monthly index is expected to grow by 0.3% after falling by 0.2% in July. 

It is worth adding that the BoE will announce its monetary policy on Thursday and that inflation levels could affect policymakers' decision. Ahead of the announcement, financial markets anticipate officials will keep rates on hold before adopting a more aggressive stance from November on. The central bank anticipated that inflation could reach 2.75% in the upcoming months before gradually declining and even falling below the 2% goal in 2025. 

Meanwhile, the BoE released a quarterly survey on public inflation expectations last week, which showed that inflation for the next 12 months is expected to fall to 2.7%, the lowest in three years. However, the 5-year perspective ticked higher, to 3.2% from 3.1% in May. The figures support the case for on-hold rates, and so will the expected CPI outcome.

Finally, it is worth noting that the UK entered a technical recession in the last quarter of 2023. Ever since the economy has recovered, but growth is sluggish, and the risk of another setback remains. 

In such a scenario, a mild deviation from the expected figures could have a limited impact on Pound Sterling. Higher than-anticipated readings could cool down hopes for aggressive rate cuts, but the path is clear. The BoE will reduce interest rates and there is no room for hikes. Even further, market participants don’t expect the BoE to deliver a cut when it meets later this week, which would likely reduce the potential impact on the currency.

When will the UK Consumer Price Index report be released and how could it affect GBP/USD?

The UK Office for National Statistics will release August CPI data figures on Wednesday at 06:00 GMT. Before analysing potential scenarios, there’s still one more thing to consider: Despite headline inflation hovering around the central bank’s goal, services inflation has remained quite hot and above 5% for most of the year, more than doubling the headline one. 

As said, a modest uptick in inflation could be seen as modest rate cuts coming, but it will not surprise investors enough to consider the opposite scenario. On the contrary, a lower-than-anticipated outcome with easing services inflation should fuel hopes for more aggressive rate cuts and put the Pound Sterling under strong selling pressure. 

Valeria Bednarik, FXStreet's Chief Analyst, notes: “The GBP/USD pair is heading into the event trading above the 1.3200 mark, and not far from the multi-month high at 1.3265 posted in August. Most of the pair’s strength is the result of the broad US Dollar’s weakness, as the Federal Reserve (Fed) is expected to deliver its first rate cut on Wednesday. The Fed’s event is likely to overshadow UK CPI release, as market players would wait until after the US central bank announcement to take positions.”

Technically speaking, Bednarik adds: “GBP/USD is bullish according to technical readings in the daily chart. A break through the aforementioned August high could lead to a quick test of the 1.3300 mark, while once beyond the latter, the rally can continue towards 1.3360. A daily close above the 1.3300 threshold would support the case for a steady advance in the days to come. On the other hand, the pair would need to slip below the 1.3140 region to put the bullish case at risk. In that case, the next level to watch and the potential bearish target comes at 1.3000.” 

Source: FXSTREET

Uncertainty over the size of an initial interest rate cut expected Wednesday from the Federal Reserve has sparked a related debate over the possibility of an accelerated halt to the central bank’s balance sheet drawdown.

Prospects for an opening cut of half a percentage point have been gaining ground over a smaller quarter-point reduction in rate futures markets, and if policymakers do go for the larger option and signal worry about the economic outlook, the runway for more quantitative tightening, or QT, could get much shorter.

QT is largely seen as a liquidity management tool and distinct from Fed interest rate policy focused on quelling inflation without inflicting too much pain on the labor market. But more aggressive interest rate cuts from the Fed might be seen at odds with tighter liquidity, depending on the reasons behind the rate cuts.

An imminent shuttering of QT would represent a major shift in the outlook for the central bank balance sheet. A survey of major banks from the New York Fed in July found firms predicting QT’s end in April of next year, as Fed officials have signaled they saw ample room to continue it.

“If they ease rates by 50 basis points, I think the decision about the balance sheet becomes more complex,” said Patricia Zobel, former manager of the New York Fed’s group that implements monetary policy and now head of macroeconomic research and market strategy at Guggenheim Investments.

“We do have some chance” of an earlier QT end if a larger cut is accompanied by concerns about the economy, Zobel said. For now, the former Fed official is anticipating a quarter-point cut and QT continuing on its current trajectory.

The Fed currently targets the fed funds rate in a 5.25% to 5.50% range.

Matthew Luzzetti, economist at Deutsche Bank, said a big rate cut joined with hints of more aggressive easing in the updated policymaker projections due on Wednesday as well would mean “there would be a conflict between reducing rates and continuing to run down the balance sheet, and they might not want that kind of mixed signal about their policy tools in that environment.”

Bank of America analysts, meanwhile, agreed a half-point cut aimed at propping up the economy would bring a halt to QT relatively soon.

The heightened rate-cut uncertainty comes down to gauging whether the Fed will be lowering borrowing costs simply to normalize them given abating inflation, and some reckon a big reduction or two could still fit along that path. But the more salient risk to the QT outlook is if interest rate policy adjusts because of rising worries about the job market hitting stall speed.

LIQUIDITY STILL FLUSH

The clouded outlook for the balance sheet comes after the QT process just crossed the two-year mark. The Fed more than doubled the size of its holdings by the summer of 2022 via purchases of Treasury bonds and mortgage-backed securities, topping out at holdings of $9 trillion. The buying was aimed at smoothing unsettled markets and providing a lift for the economy beyond near-zero percent interest rates as the COVID-19 pandemic raged.

A visualization of the evolution of Fed holdings

The QT process kicked off as the Fed shifted to rate increases to quell inflation and officials decided excessive accommodation was no longer appropriate. The drawdown has clipped about $1.8 trillion from Fed holdings so far, and in May the Fed slowed what had been a targeted monthly drawdown of $95 billion to its current limit of $60 billion.

The Fed seeks to have enough liquidity in the financial system to allow for normal short-term rate volatility and firm control over the fed funds rate. So far, discussion around ending QT has largely centered around finding that sweet spot for liquidity.

QT "is not going to be adjusted until the Fed thinks that they've made the transition from abundant reserves to ample reserves," said William Dudley, who led the New York Fed until his retirement in 2018. "They don't know exactly where, when that's going to occur, but they are pretty confident they haven't gotten there yet," he said.

So far, QT has run squarely in the background. It has faded as a market mover because investors have already "built in" QT into longer-term borrowing costs, New York Fed President John Williams said.

Meanwhile, former St. Louis Fed leader James Bullard, now dean of Purdue University's business school, noted that at least for now, QT and interest rate policy are aligned and can remain so even with rate cuts.

"Even if you lower the policy rate somewhat, it will still be above everyone's estimate of neutral, so you'd still be running a restrictive monetary policy with respect to the policy rate, and that complements the quantitative tightening part of the policy," Bullard said.

When the funds rate gets to around neutral, Bullard said that would be time to consider ending QT to better align the two policy tools. Analysts at research firm LH Meyer said any move to a fed funds rate of 3% or lower would be by itself a trigger for ending QT.

Source: Theedgemarkets

The Indian Rupee (INR) trades on a flat note on Wednesday after climbing to a month-high of 83.75 in the previous session. The downtick of the pair is pressured by the rising expectations of a deeper Federal Reserve (Fed) rate cut and robust US Dollar sales. Nonetheless, the extended recovery of crude oil prices might undermine the local currency and help limit USD/INR losses. Later on Wednesday, all eyes will be on the Fed interest rate decision, which is widely expected to cut the rate in its September meeting. Fed officials will also release a Summary of Economic Projections, or ‘dot-plot’ after the policy meeting, which could give insight into just how much the US central bank plans to cut over the next year. The expectation of the jumbo rate cuts might exert some selling pressure on the Greenback in the near term. 

Daily Digest Market Movers: Indian Rupee flatlines ahead of US key event

India's Wholesale Price Index (WPI)-based inflation declined to a four-month low of 1.31% YoY in August from 2.04% in the previous reading. This figure came in below the market consensus of 1.80%.

India’s merchandise trade deficit stood at $29.65 billion in August compared with $23.5 billion in July, according to Ministry of Commerce and Industry data released on Tuesday.

India's foreign exchange reserves rose to a record high of $689.2 billion as of September 6, according to the Reserve Bank of India (RBI).

The US Retail Sales unexpectedly rose 0.1% MoM in August versus 1.1% prior, above the market consensus of -0.2%. Industrial Production climbed 0.8% MoM in August, compared to a decline of 0.6% in the previous reading, better than the estimation of 0.2%. 

According to the CME Fedwatch Tool, Fed funds futures have priced in nearly 63% probability of a 50 basis points (bps) rate cut, up from 30% a week ago, while the chance of a 25 bps cut was at 37%. 

Technical Analysis: USD/INR’s positive outlook prevails in the longer term

The Indian Rupee trades flat on the day. The USD/INR pair oscillates within the rectangle on the daily chart. However, in the longer term, the pair keeps the bullish vibe as the price holds above the key 100-day Exponential Moving Average (EMA). Further downside cannot be ruled out as the 14-day Relative Strength Index (RSI) stands in the bearish zone below the midline, supporting the sellers for the time being.

The 83.90-84.00 zone appears to be a tough nut to crack for USD/INR buyers. This region portrays the upper boundary of the rectangle and psychological mark. A break above the mentioned level will see the next upside barrier at 84.50.

On the flip side, the initial support level is located at the low of September 17 at 83.70. A breach of this level will pave the way to the 100-day EMA at 83.64. 

Source: FXSTREET

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Gold price (XAU/USD) witnessed a modest pullback from the vicinity of the record high, around the $2,589-2,590 area touched the previous day, and ended in the red for the first time in the last four days on Tuesday. The downtick was led by some profit-taking, albeit lacking any follow-through as traders opted to wait on the sidelines ahead of this week's key central bank event risks before placing fresh directional bets. The Federal Reserve (Fed) will announce its decision at the end of a two-day meeting later this Wednesday, which will be followed by the Bank of England (BoE) meeting on Thursday and the Bank of Japan (BoJ) policy update on Friday. 

In the meantime, the extensive pricing for an oversized interest rate cut by the Fed fails to assist the US Dollar (USD) in capitalizing on the overnight bounce from its lowest level since July 2023 and revives demand for the non-yielding Gold price. However, a 25 basis points (bps) rate cut could bode well for the USD and weigh on the commodity. That said, the risk of a further escalation of conflict in the Middle East, along with the US political uncertainty ahead of the November presidential election, could offer support to the precious metal and limit the downside. This, in turn, suggests that any corrective pullback might still be seen as a buying opportunity. 

Daily Digest Market Movers: Gold price continues to draw support from a combination of factors ahead of Fed

Bets for a more aggressive policy easing by the Federal Reserve will assist the gold price in attracting some dip-buyers on Wednesday and stall the overnight modest pullback from the vicinity of the all-time peak. 

According to CME Group's FedWatch Tool, the markets are currently pricing in a 65% chance that the US central bank will lower borrowing costs by 50-basis points at the end of a two-day meeting later today.

The yield on the benchmark 10-year US government bond bounced from a 16-month low following the release of US Retail Sales data on Tuesday, albeit lacks follow-through and caps the US Dollar recovery. 

The US Census Bureau reported that Retail Sales in the US rose 0.1% in August as compared to a decline of 0.2% expected, while sales excluding Autos missed consensus estimates and expanded by 0.1%. 

The upbeat data prompted some intraday USD short-covering move and pushed it away from the lowest level since July 2023, though the positive move runs out of steam amid dovish Fed expectations. 

At least nine people were killed in simultaneous explosions of handheld pagers used by Hezbollah members in Lebanon, raising the risk of a broader Middle East war and underpinning the safe-haven metal. 

Meanwhile, North Korea, days after offering a view into a facility built to enrich uranium for nuclear bombs, test-fired multiple ballistic missiles toward the South Korean and Japanese eastern seas on Wednesday. 

The market focus remains glued to the critical FOMC policy decision, which, along with updated economic projections, including the so-called 'dot plot', should provide a fresh impetus to the XAU/USD. 

Technical Outlook: Gold price seems poised to climb further, could aim to test ascending channel resistance near $2,610

From a technical perspective, bulls might now wait for a move beyond the $2,589-2,590 region, or the all-time peak touched on Monday, before placing fresh bets. The subsequent move up has the potential to lift the Gold price above the $2,600 mark, towards testing the top boundary of a short-term ascending channel extending from sub-$2,400 levels touched late June. The said barrier is currently pegged near the $2,609-2,610 area, which if cleared decisively will confirm a fresh breakout and set the stage for an extension of the recent well-established uptrend. 

On the flip side, some follow-through selling below the overnight swing low, around the $2,561-2,560 area, could pave the way for deeper losses towards the $2,530-2,525 strong horizontal resistance breakpoint. Any further decline is more likely to attract fresh buyers and remain limited near the $2,500 psychological mark. The latter should act as a key pivotal point, which if broken decisively could drag the Gold price to the $2,475-2,470 confluence – comprising the 50-day Simple Moving Average and the lower boundary of the aforementioned trend channel.

Source: FXSTREET

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