The kneejerk reaction was for a weaker dollar as yields came off slightly as well. But all that didn't last too long as the yields bounced back alongside the dollar. Equities raced higher initially too before falling back to close lower by the end of the day. The sell the fact trade prevailed, or at least it did in the first aftershock.
As yields are continuing to hold higher, that is helping to keep USD/JPY propped up today. The pair is up another 0.6% to 143.15 currently but off its earlier high of 143.94 in Asia. 2-year Treasury yields are holding higher at near 3.64% and keeping further away from the 2023 low. So, that is a contributive factor. Meanwhile, 10-year yields are up another 3.4 bps to 3.72% currently.
"But the Fed cut more than what was expected by economists. Yields should be falling instead. Why isn't it the case?"
Even with traders paring back some pricing of a 50 bps rate cut right before the decision yesterday, it is clear that there is a decent amount of positioning for such a move. That's one. The other thing is that the Fed's dot plots show 25 bps rate cuts for both November and December. And that roughly aligns with what markets have priced in.
Traders are seeing ~69 bps of rate cuts in the next two meetings. However, when you look out to September next year, it is at ~186 bps and that isn't much changed whatsoever from before. In other words, traders were expecting at least one 50 bps move this year and one more early next year as well. And those expectations are still vindicated.
That might better explain the initial reaction we're seeing in the bond market perhaps.
After their messaging since Jackson Hole, I was still expecting the Fed move by 25 bps even though I had grown increasingly sympathetic towards the argument for a 50 bps move. But I'll hand it to Powell for at least keeping the calm in markets. The fear in moving by 50 bps was that it might signal a panic that there might be something they're seeing in the economy that's in worse shape.
However, their dot plot projection for just two more 25 bps rate cuts was perhaps the key selling point. That helped to ensure that this move was more of an insurance rather than a panic move to catch up.
All that being said, it is still a 50 bps rate cut at the end of the day. The Fed is on track to keep cutting rates from hereon. And ultimately, that means more accommodative monetary policy conditions.
If they had went with 25 bps yesterday, it might've resulted in more kicking and screaming in markets. To some extent, you can say that the Fed chose the lesser of two evils. That is if you're an equities bull I guess.
The dollar on the other hand, is somehow not really falling apart - at least for now. But at the balance, if the Fed is going to be cutting quicker than other major central banks, rate differentials dictate that the greenback should underperform against the rest of the major currencies bloc.
In particular, AUD/USD and GBP/USD might be looking more favourable for a move higher as both the RBA and BOE are still finding it tough to claim victory against inflation at the moment.
