Did the Fed Bluff the World? Rate Cut Hopes Dashed

In September, the Federal Reserve (Fed) surprised the market with a sharp 50 basis point rate cut, leading many to believe that this marked the beginning of a new round of aggressive monetary easing. However, within just a few weeks, the Fed’s stance has shifted dramatically, turning from extreme dovishness to a more cautious approach. This sudden change has left global investors feeling uneasy, with some speculating that the Fed has “bluffed” the world.

Behind the Aggressive Rate Cut

In September, the Fed’s decision to cut the federal funds rate by 50 basis points was seen as an unusual move. At the time, it fueled market expectations of a strong monetary easing cycle. However, internal divisions within the Fed were already apparent, as some officials felt a 25 basis point cut would have been more appropriate. This internal debate was highlighted in the Fed’s meeting minutes, which revealed that while the “vast majority” of officials supported the large cut, a significant number of participants voiced concerns.

Initially, the market expected another rate cut in November, but with recent positive U.S. economic data, such as the better-than-expected September jobs report, the likelihood of further aggressive easing has diminished. Traders have moved from debating whether the Fed will cut by 25 or 50 basis points in November to questioning whether there will be any rate cut at all.

Global Central Banks Follow, but the Fed Pulls Back

Following the Fed’s lead, other central banks, such as the Reserve Bank of New Zealand, also made bold moves by cutting rates by 50 basis points. However, as the Fed’s stance shifted, the pace of rate cuts by other central banks also began to slow. Investors around the world started to reassess their rate expectations, especially as the U.S. dollar made a strong comeback.

Over the past week, the dollar has clearly “awakened.” The ICE U.S. Dollar Index and the Bloomberg Dollar Spot Index both posted significant gains, hitting multi-month highs. The Fed’s sudden shift caught the market off guard, causing major G10 currencies to fall against the dollar, with the New Zealand dollar experiencing particularly sharp declines after its central bank cut rates.

Barclays’ foreign exchange strategist Skylar Montgomery Koning noted that the September U.S. labor market report was a turning point, shifting investor sentiment from bearish on the dollar to more optimistic. The unwinding of dollar short positions has further boosted its rise.

U.S. Treasury Yields Rise as Global Markets Adjust

At the same time, the U.S. Treasury market has experienced considerable volatility. The yield on the 10-year U.S. Treasury note surged past 4%, reaching a seven-week high, while 2-year and 5-year yields also rose. This rise in Treasury yields, often seen as the “anchor of global asset pricing,” has had ripple effects across global markets.

As market expectations for future rate cuts adjust, some analysts believe that the current economic data conflicts with the Fed’s earlier dovish stance. This has complicated the Fed’s internal discussions on the appropriate course for monetary policy.

The Strong Dollar Returns Amid Market Divisions

The U.S. dollar’s resurgence has created sharp divisions in global markets. Since the release of the September U.S. nonfarm payrolls report, many investors holding short dollar positions have begun closing out these trades, accelerating the dollar’s rise. Hedge funds have increased their long positions in USD/JPY, while bearish euro options have been in high demand. Sentiment toward the dollar has become the most optimistic in months, particularly ahead of the upcoming U.S. elections.

Some long-term investors from Asia and the Middle East have also been selling euros and pounds, abandoning their previously bullish outlooks on these currencies. Meanwhile, rate futures market pricing shows that traders now expect only around 44 basis points of total Fed rate cuts by the end of the year, down from nearly 70 basis points earlier in the month.

Despite the Fed’s earlier signaling of continued easing, whether it will cut rates again in November is now uncertain. The probability of the Fed pausing has risen to around 17%, according to market data.

What Is the Fed’s Next Move?

Many investors are left wondering what exactly the Fed is trying to achieve. According to the latest meeting minutes, there is significant disagreement within the Fed regarding the scale of rate cuts. Some officials believe the 50 basis point cut in September was too aggressive, arguing that a more moderate 25 basis point reduction would have been sufficient.

With economic data continuing to improve, market expectations suggest the Fed may now take a more cautious approach. Some analysts believe the Fed’s aggressive move in September was an overreaction to market pressures, and that the recent improvement in data has reduced the motivation for further cuts.

Moreover, Citi’s U.S. Economic Surprise Index, which measures the gap between actual economic data and market expectations, has recently turned positive and reached a multi-month high. This suggests that the market may have overestimated the need for further monetary easing, and the Fed’s internal momentum for rate cuts may now be weaker than before.

Global Market Adjustments and Future Trends

Whether the Fed “bluffed” the world or not, it is clear that the market landscape has changed significantly. The U.S. dollar’s resurgence has not only weighed on other currencies but also put pressure on global risk assets. The rise in U.S. Treasury yields reflects renewed confidence in the Fed’s future policy, but it also adds uncertainty to global capital markets.

Looking ahead, investors will closely watch the Fed’s November meeting and U.S. economic data. If economic data continues to improve, the Fed may hold rates steady or even consider tightening its policy stance.

As for whether Fed Chairman Powell was “deceived” by U.S. economic data or whether there are broader political considerations at play ahead of the U.S. elections, only time will tell. In the meantime, global markets are adjusting to the Fed’s policy shifts, and investors should remain cautious.

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