Will the dollar smile on a 25 bps cut, Morgan Stanley asks

The U.S. dollar has been hit hard by expectations that the Federal Reserve will start its rate-cutting cycle this week with a hefty 50 basis-point reduction, but this raises the possibility of a bounce should a smaller cut occur, according to Morgan Stanley.

The U.S. central bank starts its latest policy-setting meeting later in the session, amid growing expectations that the Fed will cut interest rates by a hefty 50 basis points at the conclusion of a meeting on Wednesday. 

Traders are pricing in a 68% chance for a 50 bps cut and a 32% chance for a 25 bps cut, CME Fedwatch showed. 

This has resulted in the U.S. dollar falling to its lowest levels this year.

“Our U.S. economists remain unconvinced that a 50bp cut is likely,” said analysts at Morgan Stanley, in a note dated Sept. 16. “They expect an unanimous decision to cut rates by 25bp, with the dot plot shifting down to show a total of 75bp worth of rate cuts by the end of 2024, versus market pricing of ~115-120bp.”

The bank’s US economists also "do not expect the Chair to give specific guidance of the pace of the cutting cycle … and likely remain data dependent, indicating that future decisions will be a function of the available data."

This outcome suggests that the Fed may not believe that the currently available data warrant a pace of easing any faster than 25bp per meeting. 

“That interpretation will likely push USD up broadly in the short term, immediately after the meeting,” the bank added.

However, beyond the knee-jerk reaction, we could see a split in USD performance, with the U.S. dollar index heading lower but USD heading up versus emerging market and commodity currencies.

 

Source: Investing.com