Market expectations for the Federal Funds rate at the end of 2024 have fluctuated recently. Before the release of July’s labor market data, the anticipated rate was at 4.66%, which was 67 basis points below the current level. Following the release of stronger ISM services data, this expectation fell to 3.85%. However, comments from Federal Reserve Chair Jerome Powell on Friday have revised the end-of-year forecast up to 4.2%. Despite this, Société Générale’s FX strategist, Kit Juckes, observes that the market remains skeptical about a 50 basis point cut in September.
Economic slowdown concerns have become more pronounced. Currently, the market is pricing future rates slightly above 3% for three years out, a level reminiscent of 1992 when inflation expectations were notably higher. The rapid decline in rates is only justifiable if the U.S. economy experiences a severe downturn. At the start of 2023, market participants were optimistic about rate cuts, but this enthusiasm appears to be waning.
Powell emphasized the importance of the labor market in his recent speech, referencing it 20 times. Although there is evidence of a loosening labor market, uncertainty remains regarding the extent of the slowdown. This uncertainty suggests that while the long-term rate expectations may not rise significantly, the market may be overestimating the number of rate cuts anticipated in the near term unless the economy decelerates sharply.
For those focused on rates, equities, and credit, the pace and scale of the economic slowdown are crucial. Conversely, in the FX market, the recent strength of the dollar is likely to see long dollar positions reduced. A mild slowdown would benefit Latin American currencies more than a severe recession would, but other G10 currencies are expected to appreciate against the dollar, provided there is a stable economic adjustment.
