Fed Signals Flexibility, Markets Eye More Rate Cuts

• Markets Now Pricing in Triple Fed Rate Cuts
• Pound-Euro Rebounds from Recent Lows

Market Recap:

Yesterday saw significant currency movements, with the US Dollar experiencing a notable decline while the British Pound found some upward momentum. Here's a breakdown of what drove the markets:

US Dollar Retreats Despite Strong Data:

• Despite positive US PMI (Purchasing Managers' Index) numbers that suggested a solid economic footing, the US Dollar surprisingly weakened.
• The catalyst for this sell-off came from Federal Reserve (Fed) Governor Michelle Bowman, who indicated she would support a July rate cut if inflation remained subdued. Her remarks echoed similar "dovish" comments from fellow Fed member Waller, leading markets to price in a more aggressive easing path than previously expected.
• This shift in Fed sentiment overshadowed the otherwise strong economic indicators, sending the GBPUSD and EURUSD currency pairs to fresh multi-year highs.
• Adding to the Dollar's woes, US consumer confidence slumped in June, with ongoing concerns about how tariffs might impact the economy and the job market.

Sterling Supported by UK Manufacturing:

• Earlier in the day, the British Pound (GBP) received a boost.
• This came after UK PMI data, particularly from the manufacturing sector, registered a slightly better-than-expected performance, lending some support to Sterling.

Canada CPI: Steady, No Immediate Policy Impact:

• In Canada, Consumer Price Index (CPI) figures held steady, with core inflation measures easing slightly. However, these numbers are not expected to significantly alter the Bank of Canada's near-term easing policy outlook.

What This Means:

The key takeaway is the growing influence of Federal Reserve commentary on currency markets. Even strong economic data can be outweighed by signs that the central bank is leaning towards earlier interest rate cuts. For UK investors, any signs of resilience in economic data like the recent PMI figures are crucial, as they could impact the Bank of England's future decisions.

Today’s Market Update:

As the trading day progresses, markets are reflecting a cautious yet complex landscape, influenced by evolving geopolitical events and central bank signals.

Dollar's Defensive Stance:

• The US Dollar (USD) remains on the back foot this morning, with Treasury yields continuing their decline.
• Despite recent hawkish comments from Fed officials like Bowman and Waller last week, who indicated a July cut was on the table, the market has interpreted yesterday's statements differently.
• Today, markets are now pricing in a 30% chance of the Federal Reserve cutting its base rate three times this year. This expectation appears to be driving the Dollar's weakness, as it implies a more aggressive easing path than some officials prefer.

Fragile Geopolitical Calm:

• Initially, markets saw improved risk sentiment yesterday and overnight, with the S&P 500 gaining 1.1% and the Euro Stoxx 50 rising 1.4%. This followed reports of a ceasefire agreement between Israel and Iran, which seemed to be holding. Equity volatility, as measured by the VIX, fell 21% from Monday's highs. Oil prices edged higher overnight but are still 11.4% lower on the week.
• However, the calm is tenuous. Just moments ago, the Israel Defense Force reported identifying missile launches from Iran towards Israel, immediately easing off those earlier "risk-on" market moves. The White House has dismissed these reports, creating a conflicting picture that keeps traders on edge.
• Adding to the geopolitical mix, President Trump is at the NATO summit in The Hague, where he's expected to redefine the US's commitment to NATO Article 5. Tensions are also escalating over EU-US trade, with a July 9th deadline looming and a threat of 50% tariffs on the bloc.

Central Bank Divergence:

• In a more hawkish turn yesterday, Fed Chair Powell indicated he would not support a rate cut until early autumn, citing risks that tariff impacts on CPI could be more prevalent in June and July data. New York Fed Head Williams and Governor Barr echoed this "modestly restrictive" and "wait and see" stance. This directly contrasts with the market's current pricing of three cuts.
• Fed Chair Powell's semi-annual policy testimony at 3 PM BST will be closely watched for further clarity on this divergence between market expectations and Fed intentions.

FX Performance & Outlook:

• The Dollar's sell-off yesterday saw the DXY (Dollar Index) drop 0.4%, with G10 risk betas (GBP, AUD, NZD) and high-carry EM currencies outperforming.
• The Euro (EURUSD) rallied 1.2% from yesterday’s lows to trade at a 1.16 handle this morning, as the market added back to USD shorts.
• GBPEUR is attempting a bounce back after recently falling to a two-month low, and GBPAUD has rebounded off one-month lows, now trading back at April highs.
• Barclays Research's Quarterly FX Outlook highlights a persistent narrative of increased EURUSD hedging flows, with the Euro acting as a liquid USD alternative for foreign investors hedging US equity holdings. They've updated forecasts to account for incremental USD weakness in the near term, particularly against GBP, CHF, and commodity FX, though they anticipate a modest USD correction higher in 2026.

What This Means:

Today's markets are a tug-of-war between renewed geopolitical jitters and conflicting signals from the Federal Reserve. The Dollar's continued weakness suggests markets are betting on more aggressive Fed easing despite official caution. Investors should remain highly vigilant on geopolitical headlines, especially around NATO and US-EU trade, and closely monitor Powell's testimony for any shifts in the central bank's stance.

25th June 2025

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