Currency slumps to three-year low due to expectations of Federal interest rate adjustments
In a move that could potentially shake up the global financial markets, the Federal Reserve is facing increasing pressure from President Donald Trump to cut interest rates. This pressure has led to a wave of bets on further dollar weakness against various currencies.
The financial markets are anticipating the Fed to reduce interest rates by approximately 75 basis points by the end of next year. This is breakdown consists of two 25-basis-point cuts in 2025 and one additional 25-basis-point cut in 2026, totaling around 0.75 percentage points in reductions.
This expectation is not without basis. The Bloomberg Dollar Spot Index has seen a three-day consecutive fall, and the unemployment rate in the U.S. has risen to its highest level since 2021. The labor market could face a more significant deterioration in the coming months.
However, it's important to note that a rate cut is unlikely to exceed a quarter point, as per the current information. This means that the most significant reduction we might see in the near future is a 25-basis-point cut.
The Fed's two-day meeting began on Tuesday, and traders are eagerly awaiting the Federal Reserve's announcement regarding interest rate cuts. Tuesday's unexpectedly strong U.S. retail sales data did not dispel expectations of a rate cut, indicating that the economy's health is not as robust as the data might suggest.
U.S. employment growth cooled significantly in August, further fueling the rate cut expectations. Hedge funds have responded by expanding their options trading, betting that the dollar will continue to lose value against a range of currencies, including the euro, yen, and Australian dollar, in the coming months.
The euro, in particular, has seen a surge, rising to a four-year high on Tuesday. The Swiss franc also reached its highest level against the U.S. dollar since 2015. The yen has gained against the U.S. dollar as well.
The European Central Bank is not expected to implement further rate cuts, narrowing the gap between its policy rate and the Fed's. This could potentially lead to a stronger euro and yen against the dollar.
Market participants will closely watch the Fed's dot plot, which shows how much more easing policymakers expect in the coming months. The probability of a half-point cut by the Fed is very low, suggesting that any rate adjustments will be gradual and cautious.
As the Fed's decision looms, the global financial markets remain on edge, waiting to see how the Fed's rate cut will impact the dollar and the broader economy.
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