Monday was an active day for monetary policy that could have an impact on forex markets, with the heads of the two largest central banks giving speeches that included hints about future moves. Markets have adjusted to the path for rates being on the downside. But just how fast each bank will cut will have a big impact on how the currency pairs move over the coming months.
Fed Chair Jerome Powell had a bigger impact on the market, as his comments seemed to contradict the narrative that traders had been operating under. Meanwhile, ECB President Christine Lagarde also largely reiterated her stance, without addressing the growing divide among policymakers regarding the ECB inflation.
The Market Reaction
Although both central bank heads gave dovish remarks compared to previous stances, the markets didn’t particularly like their stance. Specifically, they didn’t appear to be dovish enough. In the case of the Fed’s Powell, he said that two rate cuts would be reasonable given the current trajectory of the data. That implies one in November and the other in December.
But markets were expecting three cuts, with a “double” in the last month of the year. As a result, gold prices tumbled in the wake of Powell’s comments along with the stock market. Bonds rallied, but the dollar didn’t gain all that much as traders evaluated other currencies in the basket.
Europe on the Easing Path
Lagarde’s comments were overshadowed by her expression of support for Unicredit’s potential takeover of Commerzbank. The consolidation of European banking isn’t immediately relevant to forex, but following the merger of UBS and Credit Suisse, the financial system in Europe is becoming increasingly top-heavy. That brings renewed concerns over too-big-to-fail banks, and a potential economic event could cause faster and more impactful contagion.
As for monetary policy, the main takeaway from the head of the ECB was saying that the shared central bank was becoming “increasingly confident” that the ECB Inflation will come down to target. That seemed to hint that further easing might be in the offing, though she did couch the remarks by saying inflation would likely rebound in the latter part of the year. Lagarde seems to be treading carefully between the two camps in Frankfurt over whether to take an aggressive easing stance comparable to the Fed, or to slowly bring down rates and focus on price stability.
Where Markets Could Go
While the initial reaction from the markets was a bit disappointing as they were expecting more easing, the ease with which central bank heads talk about cutting rates shows how certain the downward trend is. Markets can quibble over whether easing will happen at this meeting or the next, but in terms of currency moves, there are some clear winners and losers.
The Fed, with relatively high rates and signs of a sluggish economy, has more room to cut than the ECB. The shared economy is already stagnant if not in technical recession, but services inflation remains high due to energy imports. Weakening the Euro through more rate cuts would likely make the energy cost issue an even bigger problem. Which means that the dollar has more downside than the Euro in the medium to long term.
