The first cut is the deepest – Commerzbank

The time is ripe for interest rate cuts – that was Fed Chair Jay Powell’s key message on Friday in Jackson Hole. How fast and how far the interest rate cut cycle will go? Powell could only say: It depends on the data, Commerzbank’s Head of FX and Commodity Research Ulrich Leuchtmann notes.

USD weakness after Powell’s speech in Jackson Hole

“The USD sell-off continued forcefully. Even without any surprising dovishness of the chairman. The market’s expectations (those implicit in the fed funds futures) of what the Fed will do in September, November and December have hardly changed as a result of Powell’s speech. They had already fallen after the last US labor market report.”

“The only thing that helps here is to understand exchange rate changes as shifts in risk premiums for one currency or another. Anyone selling USD today must be aware of the risk that the Fed will eventually switch back to a more restrictive monetary policy and that the long-term US real interest rate expectations that are priced in today will turn out to be wrong.”

“For USD exchange rates, this means that this ‘first-cut effect’ currently prevails: the market’s increasing confidence in its expectation of lower USD interest rates (in the long term) is more important than the question of where exactly interest rates are expected. However, the market cannot be more than fully convinced. Once it is, it comes down to how low US interest rates are expected to be.”