USD: Interest rate decisions in uncertain times – Commerzbank

While the financial markets were almost in a 'celebratory mood' in view of the looming end of the US government shutdown, EUR/USD remained flat yesterday. The price moved within a narrow range around the 1.1550 mark. My colleague Michael explained yesterday that the US currency had recently benefited from a lack of US data as a result of the closure of many US government agencies. This support is now likely to disappear, which is why an end to the shutdown is actually a negative factor for the dollar. The reason is that the probability of a further rapid interest rate cut by the Fed has now increased, Commerzbank's Head of FX and Commodity Research Thu Lan Nguyen notes.

Fed has reasons to lean toward an expansionary monetary policy

"Fed Chair Jay Powell pointed out after the Fed's September meeting that the FOMC was deeply divided on how to proceed. While some members favor continuing interest rate cuts, others would prefer to wait and see. One reason for a more cautious approach would be – according to Chicago Fed President Austan Golsbee, for example – the lack of data due to the shutdown. Golsbee was particularly concerned about the inflation risks that could become apparent very late as a result. Further interest rate cuts would therefore make him uneasy. If the shutdown ends soon, this argument would become weaker."

"Of course, one could also argue the opposite: a significant weakening of the labor market could also become apparent late for the same reason, causing the Fed to fall behind the curve. This was the view expressed by San Francisco Fed President Mary Daly, who warned against keeping interest rates too high for too long in view of a weakening labor market. The question is which of the two scenarios would be worse: a weaker-than-desired labor market or faster-rising inflation. History tells us it would be the former. In the past, the Fed has proven that it can bring rampant inflation back under control by means of restrictive monetary policy when necessary – even if this has not been without pain. The other scenario – a rapid slowdown in employment associated with a recession – may prove more difficult."

"In the current uncertain situation due to a lack of reliable data on inflation and the labor market, I therefore believe that the Fed has good reasons to lean toward an expansionary monetary policy – regardless of the additional political pressure it is under. I consider the recent (albeit slight) decline in expectations of interest rate cuts to be unjustified and see it more as another argument for a weaker dollar."