UK Inflation Data to Give Last Hint to Boe Before Deciding on Interest Rates

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

[Quick Facts]

[News Details]

[Today's Focus]

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

Macro:

Market Picture

The crypto market capitalisation remained at $2.04 trillion, the same as the previous day, although it fell to $2.01 trillion during the day before rebounding on Tuesday morning. The Cryptocurrency Sentiment Index returned to the fear zone after briefly rising to neutral levels on Saturday and Sunday.

Bitcoin is trading at $58.6K, having gained 1.7% since the start of the day. However, it remains below its 50-day moving average, which is pointing lower. This resistance level has seen increased selling activity, signalling a cautious sentiment ahead of the Fed’s rate decision.

Ethereum is trading around $2300, testing support at the 200-week moving average for the third consecutive week. Since 2020, Ethereum has repeatedly found support from long-term buyers when falling towards this line or shortly after breaking it. However, without visible buyer support this time around, long-term investors may start to capitulate and doubt the prospects of the second-largest cryptocurrency. At the same time, the RSI is approaching the oversold territory, suggesting more chances of a bounce than a continuation of the decline in the absence of buyer capitulation. As such, the coin’s momentum will be telling in the coming weeks.

News Background

According to CoinShares, investments in crypto funds rose by $436 million last week after two weeks of outflows. Investments in Bitcoin increased by $436 million, Solana increased by $4 million, and Ethereum decreased by $19 million. Investments in multi-asset crypto funds increased by $23 million. The surge in inflows at the end of the week was driven by a significant shift in market expectations for a potential 50bps Fed rate cut following comments from former New York Fed President Bill Dudley. Ethereum continues to struggle, which CoinShares believes is due to concerns over the network’s profitability following the Decun update.

WeRate calculated that Bitcoin’s rally could begin in the next 22 days based on previous historical cycles. The rally began around 170 days after the halving, with the peak occurring 480 days later. Crypto investor Lark Davis recalled Bitcoin’s impressive Q4 gains during the halving years. BTC also closed with growth in Q1, Q2 and Q3 of the year after the event.

The Ethereum developers have proposed to split the major Pectra update into two parts. They plan to activate the first phase in early 2025.

USDT stablecoin issuance on the TON blockchain exceeded $1 billion. The Telegram-connected ecosystem climbed to fifth place in terms of issuance of the largest stablecoin from Tether in five months.