Overnight, the US Federal Reserve’s Open Market Committee kept the policy rate unchanged but gave the clearest hint yet that rate cuts are imminent. The key change in the statement is the committee is now “attentive to the risks to both sides of its dual mandate”, rather than a focus on inflation (as was the case for the past two years). At the press conference, market participants probably caught on that this decision is not unanimous and some FOMC members probably wanted a cut at the recent meeting. Note that the Fed still characterised US economic activity as expanding at a “solid pace.” Accordingly, our view of calibrated cuts (beginning in September) still appears to be the most likely scenario going forward.
USD rates (2Y to 10Y) look low under our assumption of soft-landing and calibrated Fed cuts. 2Y and 10Y yields are at levels seen in January when the market was aggressively (and wrongly) pricing in a Fed pivot. This time, we think the Fed will deliver, but the extent of cuts priced in (200bps over the next two years) may be too large. Yields at current levels would require US data to soften significantly from here on, thereby allowing the Fed to have an extended rate cut cycle. That is not a given. Worries on the US elections and the US’s fiscal situation could return. Fed speak over the coming couple of weeks may push back against current dovish pricing. In any case, data (starting with NFP on Friday) would be the most important factor determining the pace / extent of Fed cuts at a time when sentiment is holding up.
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