USD: The many facets of the Fed meeting - Commerzbank

Today's Fed meeting promises to be one of the most exciting in a long time, as it holds plenty of potential for surprises. Let's start with the interest rate move: a 25 basis point cut is fully priced in. This move has been signaled by comments from Fed officials, including Fed Chair Jerome Powell, as well as the latest extremely weak labor market data. However, there is a residual risk that the Fed will even cut interest rates by 50 basis points, similar to what it did a year ago, Commerzbank's Head of FX and Commodity Research Thu Lan Nguyen notes.

Risk of further USD weakness

"As was the case a year ago, a larger interest rate cut would put significant pressure on the dollar. This is due to two factors: First, inflation is rising, albeit not as quickly as expected shortly after the announcement of extensive US tariffs. A larger interest rate cut would nevertheless signal that the Fed attaches greater importance to real economic risks than to inflation risks. Second, concerns are likely to arise that more aggressive monetary easing is being pursued due to political pressure. After all, Stephen Miran, a close ally of US President Trump, is attending the meeting for the first time, and there is a high probability that he will convey the president's pressure to cut interest rates to 1% as quickly as possible."

"The voting ratio holds further potential for surprises. Miran is expected to vote for a 50 basis point cut. If Christopher Waller and Michelle Bowman, who already voted against the consensus for an interest rate cut at the last meeting, join Miran, this would certainly be interpreted as a sign of the Fed's politicization and put corresponding pressure on the dollar. This would also be the case if the three remained alone in their vote for a more substantial interest rate cut. After all, it would be foreseeable that future Fed governors appointed by Trump would also comply with his wishes just as Miran, Waller and Bowman do."

"Last but not least, there are the Fed's new forecasts, above all the infamous 'dot plot', i.e., the interest rate expectations of the individual FOMC members. Here, it all comes down to the combination: if the Fed lowers its interest rates by 25 basis points as expected but at the same time significantly revises its expectations for the Fed Funds Rate for the end of this year and next year downwards, this would also be a negative signal for the dollar. If, on the other hand, the Fed unexpectedly cuts its key interest rate by 50 basis points but only hints at moderate interest rate cuts beyond that, this would be less detrimental to the US currency. In short, there are many conceivable scenarios, so I would prepare for increased volatility and, in my view, above all for the risk of further USD weakness."