Federal Reserve Signals Caution, Traders Price In September Rate Cut

Traders have fully repriced the likelihood of a Federal Reserve rate cut in September, indicating a significant shift in market expectations. This change is driven by economic indicators and policy statements from the Federal Reserve, which suggest a more cautious approach to monetary policy. The Federal Reserve has kept interest rates unchanged, highlighting increased uncertainty in the economic outlook. The Federal Open Market Committee (FOMC) unanimously decided to maintain the federal funds rate at 4.25%-4.50%, noting that the US economy continues to expand steadily, the labor market remains robust, and inflation is still rising. However, the Fed acknowledged that the uncertainty in the economic outlook has further increased, with rising risks of a higher unemployment rate and inflation.

The market's reaction to this stance has been one of anticipation, with traders now fully pricing in a rate cut by September. This shift is driven by several factors, including the Fed's acknowledgment of increased economic uncertainty and the potential for a more substantial rate cut once the Fed begins to lower rates. Analysts have pointed out that consumer and business confidence has plummeted to levels consistent with a historic recession, raising concerns for the Federal Reserve. Economic uncertainty and government spending constraints imply that a trade agreement and tax cuts must be reached as soon as possible to prevent stagflation. Nevertheless, there is room for the Federal Reserve to cut rates later this year, with housing-related deflation providing some leeway.

The Federal Reserve's "wait-and-see" stance is expected to continue for several policy meetings, as officials assess the impact of government trade policies on inflation while the labor market remains strong. Higher tariffs are expected to increase prices, while port operators and logistics companies warn of potential supply tightening risks, which could exacerbate short-term inflation threats. Therefore, the Federal Reserve is in a "wait-and-see" mode, with Chairman Powell warning that the Fed's responsibility is to keep long-term inflation expectations stable and ensure that one-time price increases do not turn into a persistent inflation problem.

The market's focus on the Federal Reserve's actions has been limited, with the dollar weakening slightly after the FOMC's statement but showing an overall muted response. The impact of short-term interest rate spreads on dollar cross rates has been minimal, and the dollar is more pressured due to the Fed's concerns over rising unemployment and inflation. The exchange rate of the euro against the dollar is expected to receive sustained support in the short term, with the overall risk balance tending towards the upside for this currency pair.