The Moment of Reckoning is here !! 25 or 50 Bps and the SEP || Benign PCE Expectations || USDJPY 145.75 or 137.50 ??

“Every once in a while, an up-or-down-leg goes on for a long time and/or to a great extreme and people start to say "this time it's different." They cite the changes in geopolitics, institutions, technology or behaviour that have rendered the "old rules" obsolete. They make investment decisions that extrapolate the recent trend. And then it turns out that the old rules still apply and the cycle resumes. In the end, trees don't grow to the sky, and few things go to zero.” ~ Howard Marks

Bonds continued to rally this week with yields on US2s printing a high and low range of 3.71% - 3.55% to close the week at 3.584% and US10s printing a high and low range of 3.76% - 3.6050% to close the week at 3.655%. I highlighted in my blogpost on Aug 31, the triangle breakout target at 15.50 bps on US2s10s. We dipped to -0.004% on the CPI release and closed the week at 0.0710%. On Crude Oil prices we dipped to lows of $ 68.71 but closed the week higher at $ 72.09. ECB announced a 25 bps Rate cut to 3.5% and prefers to follow a data dependent approach to Policy Making. DXY has not done much since the 27 Aug lows and has largely been range bound between 100.50 - 101.85. 

Through the week, the highlight was the Trump - Harris Presidential Debate, CPI, PPI, IJC & CJC plus Michigan Consumer Sentiment and the article from WSJ Nick Timiraos - "The Fed's Rate Cut Dilemma: Start Big or Small"? - which added a whole lot uncertainty to the Fed Decision. 

Fed Fund Futures show a market split right at the center between the 25 bps and 50 bps camp. Jim Bianco points out that  Fed designed forward guidance to prevent this exact scenario and to resolve this he expects a story clarifying the 25 / 50 bps debate to hit the wires by Monday Morning and absence of such clarification will lead to a discussion that forward guidance is dead and Markets will have to adjust to a world of less Fed Clarity by putting larger risk premiums. Markets pushed the probability of 250 bps of rate cuts in the next year to 92% from 74% last week. 

The latest Polls show Harris having a 2% point lead over Trump.

The Headline CPI rose 0.19% mom with energy prices down 0.78% mom and food growing at a very benign 0.12% mom. The Core CPI prices were up 0.30% driven by Shelter, Transportation Services, Education and Apparel. Shelter continues to weigh on the inflation progress as Shelter Prices rose 0.52% mom. The Super Core Services rose 0.11% mom and at 1.27% yoy. The 3 month annualized Rate of growth for Super Core Services was at 1.50%.

The PPI for Final demand rose 0.24% mom driven by a -0.92% decline in Energy prices and PPI for Services rose at 0.37% mom. 

The Jobless Claims data did not offer much by way of a catalyst.

Post the CPI and PPI release, Cleveland Inflation Nowcast estimates Aug PCE and Core PCE at 0.19% mom and 0.23% mom respectively which translates to a headline reading of 2.28% and Core reading of 2.76%. Likewise, the PCE and Core PCE Estimates for the month of September are seen at 2.10% yoy and 2.66% yoy. The Atlanta Fed GDPNow estimates Q3 GDP at 2.5%. 

I expect Federal Reserve to begin the Rate Cutting Cycle by announcing a 25 bps cut ( while keeping a close eye on the wires from the likes of WSJ to update expectations). While the direction of Policy is amply clear, arguments can be made in favor of both the 25 bps and 50 bps cut. Policy setting is restrictive considering PCE inflation for Aug is estimated at 2.76% , there is ample space and the Fed would like to engineer a soft landing so why not a 50 bps cut. How much is Fed's decision contingent on Market reaction function to a 50 bps cut can only be hypothesized. 

So to me the decision to cut 25 bps or 50 bps is secondary to the SEP guidance. My own  expectations from the SEP are 75 bps of rate cuts in 2024 - so median dot at 4.625% followed by 100 bps of rate cuts into 2025 to 3.6250% and 75 bps of rate cuts in 2026 which take the median dot to 2.875%. Market is pricing in an aggressive rate cutting cycle and I am leaning towards a Fed that is more hawkish than the current dovish expectations. 

Find below the Summary of Economic Projections (SEP) released by the Federal Reserve in June. 

Looks like we have a wedge formation on the USDJPY and if we get a 25 bps cut from the Fed and a Fed more hawkish that the current market pricing, USDJPY could rally back towards the 145.75 handle where I would like to put on shorts or if the Fed delivers on the current market pricing, a breakdown below 140 could take the pair further to 137.50 handle.

The week will see the release of Retail Sales, Industrial Production, Housing Starts, Building Permits, FOMC Rate decision along side Statement of Economic Projections, Jobless Claims and Existing Home Sales Data. On Thursday, we also have the release of the Bank of England Policy Decision followed by BoJ Policy Decision.