Dollar May Surge Short-Term if Fed Misses Rate-Cut Promises

U.S. Federal Reserve's Expected Rate Cut and Its Impact on the Dollar

The U.S. Federal Reserve is anticipated to cut interest rates on Wednesday, a move that could have significant implications for the dollar. According to HSBC’s Paul Mackel, the dollar may experience a brief increase following the announcement, provided the Fed does not signal an extensive series of rate reductions. The market currently prices in approximately 140 basis points of rate cuts by the end of 2026, according to LSEG data. However, any gains in the dollar would likely be short-lived if further rate cuts are expected, especially if employment data remains weak.

The DXY dollar index has recently dropped to a nearly one-week low of 97.298, indicating some volatility in the currency markets. Analysts suggest that while the initial reaction might be positive for the dollar, the long-term trend could still favor a decline due to expectations of continued rate cuts.

Euro Could Benefit from a Weaker Dollar

The euro may see an upward movement as the dollar weakens, particularly if the U.S. Federal Reserve continues its rate-cutting cycle. ING analysts predict that the euro could rise to $1.20 by year-end, up from its current level of $1.1768. This projection is based on the expectation of three consecutive rate cuts by the Fed in 2025, starting with the upcoming decision on Wednesday.

Seasonal factors such as U.S. corporate tax payments may temporarily support the dollar in September, but analysts expect a decline thereafter as the Fed reduces rates. The euro’s potential to rise depends largely on a broader weakening of the dollar, even though the European Central Bank has likely concluded its rate-cutting phase.

U.S. money markets indicate a 93% probability of a 25 basis-point rate cut at the Fed’s remaining meetings in 2025, including September, October, and December. This suggests that the euro could benefit from a more sustained decline in the dollar over the coming months.

Chinese Yuan Faces Constraints Amid Slow Economic Growth

Slowing economic growth in China may prevent policymakers from allowing the yuan to strengthen significantly in the near term. MUFG Bank’s Lee Hardman notes that the People’s Bank of China adjusted the daily fix for the dollar versus the yuan lower in the second half of August, which allowed the yuan to appreciate slightly. However, the dollar has remained just above 7.1000 yuan during the first half of September.

China’s economy appears to be slowing down in the third quarter after posting a 5.3% growth rate in the first half of the year. Key economic indicators for August, including retail sales, industrial production, and fixed asset investment, fell below expectations. As a result, the dollar remains relatively stable at 7.1215 yuan, reflecting the cautious approach of Chinese policymakers.

Sterling May Decline If the Bank of England Maintains QT Pace

Sterling could face downward pressure if the Bank of England maintains its quantitative tightening (QT) pace at Thursday’s meeting, leading to upward pressure on U.K. government bond yields. HSBC forex analyst Paul Mackel highlights that the latest BOE market participants survey estimates a median reduction in QT to 72 billion pounds over the next 12 months, starting in October.

The BOE has reduced its gilt holdings by 100 billion pounds over the past year. Analysts believe that the BOE’s decision on QT this week could impact the pound, given the scrutiny of long-end bond yield movements in countries with large fiscal burdens, such as the U.K.

Fed’s Balance Sheet Plans Could Influence the Dollar

The Federal Reserve’s balance sheet plans may have important implications for the dollar. Commerzbank’s Thu Lan Nguyen notes that recent comments from Treasury Secretary Scott Bessent suggest support for a faster reduction of the Fed’s balance sheet. After the pandemic, the Fed significantly reduced its balance sheet to combat inflation, but the pace has slowed since spring this year.

A return to a faster reduction, especially in government bond holdings, could diminish the effectiveness of interest-rate cuts demanded by certain political figures. This, in turn, could benefit the dollar. The DXY dollar index is currently down 0.2% at 97.404, indicating some resilience despite the ongoing discussion around the Fed’s balance sheet strategy.

Dollar Resilience Despite Expectations of Rate Cuts

Despite the recent drop in short-term U.S. yields driven by expectations of Fed rate cuts, the dollar has shown resilience. MUFG Bank’s Lee Hardman states that investors remain hesitant to price in a larger than 25 basis-point reduction. For short-term U.S. yields to continue falling and provide a fresh trigger for a further decline in the dollar, the Fed would need to deliver a larger rate cut or signal the possibility of more substantial cuts.

The DXY dollar index is currently steady at 97.518, reflecting the market’s cautious stance on the extent of the Fed’s rate-cutting efforts.

Euro’s Modest Reaction to Fitch’s France Rating Downgrade

The euro’s response to Fitch’s downgrade of France’s credit rating has been minimal, as the move was not unexpected. ING’s Chris Turner notes that the focus is now on whether new French Prime Minister Sebastien Lecornu can convince lawmakers to implement fiscal consolidation measures. Analysts believe that while the eurozone is unlikely to face a broader crisis, market participants will continue to monitor French debt closely.

Fitch downgraded France’s rating to A+ from AA- after former Prime Minister Francois Bayrou lost a confidence vote over his budget plans. The euro has seen a slight increase after an earlier dip, currently trading at $1.1738.

Sterling Gains Against the Dollar Amid Diverging Rate Cut Expectations

Sterling rises to a one-month high against the dollar as interest-rate expectations favor the currency ahead of policy decisions from both the Bank of England and the Federal Reserve. The BOE is expected to keep rates unchanged on Thursday, with markets pricing in only 10 basis points of rate cuts this year. In contrast, the Fed is anticipated to cut rates by 25 basis points on Wednesday, followed by nearly two more cuts this year.

This divergence in rate cut expectations has contributed to the pound’s strength, with the currency reaching a high of $1.3593. The euro, however, falls 0.2% to 0.8634 pounds, reflecting the relative strength of the dollar and the pound in this context.

Dollar Edges Higher Ahead of Fed Rate Decision

The dollar moves higher ahead of the Federal Reserve’s policy decision on Wednesday, with markets expecting a 25 basis-point rate cut. Danske Bank analysts anticipate a gradual rate-cutting cycle rather than back-to-back reductions. They point to the University of Michigan’s consumer confidence survey, which showed elevated inflation expectations, as a factor influencing the Fed’s decision.

The DXY dollar index rises 0.1% to 97.665, indicating a cautious yet positive outlook for the dollar as it approaches the key decision date.

Euro Falls Slightly After French Rating Downgrade

The euro declines slightly after Fitch downgrades France’s credit rating to A+ from AA-. The move follows the ousting of former Prime Minister Francois Bayrou in a confidence vote over his budget plans. New Prime Minister Sebastien Lecornu faces the challenge of implementing fiscal consolidation measures to reduce the deficit.

Analysts warn that there is a risk of additional downgrades from other ratings agencies. The euro falls 0.1% to $1.1720 and 0.1% to 0.8644 pounds, reflecting the market’s concern over France’s fiscal stability.