US GDP circa 2-3% range, unemployment sub-4%; cuts currently not required. But consensus view is that Fed cuts in 2H, and the USD weakens

By Stuart Talman, XE currency strategist

Low volatility tight range trading has been the status quo over the past six weeks as the market has converged with the Fed's outlook, both now aligned to project around three quarter point cuts through 2024.

The New Zealand dollar has mostly ranged between 0.6050 and 0.6200 during this span, threatening to break out to the upside early last week before the RBNZ poured water on the Kiwi's ascent by maintaining current policy settings whilst lowering the projected OCR peak.

Price action has been squeezed into tight intraday ranges over the past three trading days and may continue to track sideways for much of this week as the market slips into wait-and-see mode ahead of the week's headline event, the February US jobs report.

An upside surprise to the projected non-farm payrolls (NFP) result of 190K new jobs would pose the question: does the Fed need to or want to cut rates in 2024?

Via the CME Fedwatch tool, which assigns an implied probability (derived from the Fed funds futures curve) to changes in Fed policy at upcoming FOMC meetings, the current probabilities of a 25 bps cut at the next two meetings are 21.5% on 01 May and 52.1% on 12 June - therefore pretty much a coin toss the Fed will commence hiking by mid-year. 

There is a path by which the Fed doesn’t cut at all, this year.

Data flow out of the US remains robust compared to other major economies, the widely observed Atlanta Fed's GDPNow forecasting tool estimating a 2.1% growth rate for the world's largest economy for the first quarter. Last week, the Bureau of Economic Analysis released its second estimate for fourth quarter GDP, economic activity in the US grew at an annualised 3.1%.

Compare this to the UK and Japan - growth contracted in the December quarter. Domestically, the economy contracted -0.3% in the September quarter. Fourth quarter GDP is reported on 21 March.

The unemployment rate in the US last printed above 4% in January 2022 whilst NFP has recorded monthly jobs gains of 182K, 333K and 353K over the past three months.

The S&P500 and Nasdaq are logging fresh record all-time highs. Consumer sentiment and household spending in the US has a positive correlation to the direction of equity markets - when they rise, confidence increases, households spend.

These are not conditions that will prompt the Fed to commence an easing cycle.

In December 2015, the Fed raised the Fed funds target rate by 25 bps to 0.25% to 0.50%. Its next hike was in December 2016.

What major event occurred between these two hikes?

A US election - Trump elected in November 2016.

Whilst this time is different, the Fed is expected to cut rates, rather than hike, an election year begs the question: will the Fed again sit on the sidelines?

The Federal Reserve is (or at least is supposed to be) apolitical. 

Provided the US economy does not materially deteriorate in the months ahead, the Fed may prefer to do nothing in order to remain out of the spotlight as election campaigning and ultimately the result, plays out. As was the case in 2016, they don’t want be part of the narrative.

So, if the Fed's not cutting by 12 June, might they cut at the next FOMC meeting, scheduled for 31 July?

The Republican convention is held on 15-18 July, whilst the Democratic Convention is held on 19 - 22 August.

If the Fed decided to commence a monetary easing cycle a couple of weeks after the Republican convention, there is no doubt that Trump and his supporters will go to town on chair Powell, accusing the Fed of trying to tip the election scales in favour of Biden and the Democrats.

Conversely, if the economy visibly weakens through the second quarter and the Fed commences cutting in July, this will also provoke the ire of the Democrats, likely to chastise the Fed for not cutting earlier in the year.

If the Fed had commenced easing at the March or May meetings, a July cut would be more palatable and not be viewed through political lens.

Beyond July, there are FOMC meetings on 18 September and 07 November. Voting takes place on 05 November.

It can be reasoned that the Fed won't commence hiking the meeting before the election, as again, this may be interpreted as politically influenced, as would a cut a couple of days after voting.

The 18 December FOMC meeting may produce the sole rate cut for 2024……or perhaps none at all.

Now, we're dealing in hypotheticals and making what may be a flawed assumption regarding the Fed's desire to prioritise being perceived as politically neutral over its inflation and growth mandates, so the path of no cuts may prove non-existent.

And, of course after all that is said and done, the economy's underlying metrics should be the overarching factor……but, as we laid out earlier in this morning's update, current economic conditions don't warrant monetary easing.

The motivation for this morning's update was to make you aware that the consensus view of the Fed cutting and thereby the dollar weakening through the second half of the year may not play out as expected.

Hot jobs numbers Friday would most certainly tip the odds in favour of an on-hold decision in June and no doubt fuel the narrative of higher, for even longer.

To the day ahead, the regional events that may move the needle include Tokyo CPI, and China’s Caixin Services PMI. The ISM Services PMI is the sole tier 1 data release in offshore trade.

We anticipate tight range trading to prevail, NZD/USD to teeter either side of 61 US cents.

Stuart Talman is Director of Sales at XE. You can contact him here.