A marginally softer dollar post-FOMC
The dollar softened modestly after the Fed held rates, despite a hawkish vote and stronger activity assessment. Attention now turns to US GDP and PCE inflation.
USD
The dollar softened modestly on Wednesday after the Fed delivered a hold at 3.75-4.00% that we and markets had expected, with the DXY slipping 0.2% to just above 102. On paper, the outcome was hawkish, as we anticipated: a 10-2 vote with Cook and Hammack dissenting in favour of a hike, and a statement upgrading activity to “expanding at a strong pace”. But Chair Warsh declined to guide towards December, and his announcement that one 2027 meeting and two 2028 meetings will carry no rate vote was read as a signal that the Fed intends to act less often. Front-end yields fell, the curve steepened, and December hike pricing eased to around 80%. We still look for a 25bp hike in December given the energy shock from the Middle East war, and we think the post-Fed dip in the dollar has limited room to run. Today brings advance Q3 GDP and September PCE at 12:30 GMT, with growth seen around 3% annualised and core PCE expected at 0.3% MoM, prints that should re-firm December odds, and the buck.
EUR
EURUSD bounced 0.3% on yesterday’s Fed decision but has given back some of that overnight. That the euro could only muster a modest rally on a softer dollar underlines the impact of a weak domestic backdrop, a point reinforced by yesterday’s disappointing GfK consumer confidence. Today, the ECB announces at 13:15 GMT and should hold the deposit rate at 2.50% following September’s hike, with markets pricing in next to no chance of tightening. The reaction will therefore hinge on Lagarde’s press conference from 13:45 GMT. With September HICP at 3.8%, TTF gas near €100/MWh and Houthi strikes on Saudi infrastructure keeping Brent near $115, we expect her to keep a December hike (roughly 75% priced) firmly on the table while deflecting questions on France and TPI eligibility. That is probably the hawkish-leaning hold markets want, but given the challenging backdrop, we doubt it is enough to lift the euro sustainably.
GBP
Sterling did what we expected on Budget day, which is to say very little. Chancellor Healey delivered the low-key statement we had pencilled in, rebuilding headroom to £15bn, leaving headline tax rates untouched and deferring the big spending decisions to the 2027 Spending Review. Gilts rallied modestly, with 10-year yields down around 2bp to 5.32%, and a bank surcharge of 6% rather than the feared 8% helped UK banks outperform. GBPUSD dipped briefly before closing marginally higher as the dollar faded post-Fed, while the pound also gained through the afternoon against a France-burdened euro. We would caution against reading too much relief into this, however. Borrowing is now forecast higher in every year of the forecasts, the OBR has cut 2027 growth to 1.0%, and real wage growth is expected to stagnate. Moreover, with the Chancellor kicking the can on major decisions, we estimate £30-50bn of annual spending pressures that need to be addressed in 2027 against a £15bn buffer, meaning yesterday’s event only defers the economic pain. This, we suspect, will be a sterling focus today. With the morning papers already scrutinising the credibility of these updated spending plans, growing scepticism should prove a headwind for the pound.
CAD
The Bank of Canada surprised us, delivering the 25bp hike to 2.50% that markets had priced in, but we had judged premature. The first increase since July 2023 was justified almost entirely by energy. With the Middle East war now in its eighth month, the Bank dropped its assumption that oil prices would fade and now sees headline inflation near 3.5% by year-end, averaging 3% in 2027 and only returning to target in mid-2028. That said, Governor Macklem was careful to stress that the Bank will “proceed carefully”, one meeting at a time. This helped keep the loonie little moved on the day, though we still think risks are skewed to the upside for USDCAD, given swaps price in a roughly 45% chance of another hike in December. As we see it, back-to-back rate hikes are hard to square with data showing CPI ex-gasoline at 2.2%, the Bank’s preferred core measure at 1.85%, and the economy has shed around 110k jobs over two months. With the Fed likely to outpace the BoC in December, we see USDCAD drifting back towards 1.41-1.42 as Canadian rate pricing fades, unless oil spikes again.