Federal Reserve set for first interest-rate reduction in four years amid growing bets of jumbo cut

The Federal Reserve is widely expected to lower the policy rate after the September meeting.
The revised Summary of Economic Projections and Fed Chairman Powell’s remarks could provide important clues about the rate outlook.
The US Dollar faces a two-way risk depending on the size of the interest rate cut.

The US Federal Reserve (Fed) will announce monetary policy decisions following the September policy meeting and release the revised Summary of Economic Projections (SEP), the so-called dot plot, on Wednesday. Market participants widely anticipate that the US central bank will lower the policy rate, but the size of the cut is up in the air.

The CME FedWatch Tool shows that markets are currently pricing in a nearly 60% probability of a 50 basis points (bps) rate cut against a nearly 40% chance of a 25 bps reduction. The market positioning suggests that the US Dollar (USD) faces a two-way risk heading into the event.

The US Bureau of Labor Statistics reported last week that the core Consumer Price Index (CPI), which excludes volatile food and energy prices, rose 0.3% on a monthly basis in August. This reading followed the 0.2% increase recorded in July and came in above the market expectation of 0.2%. Following this report, investors saw a diminishing chance of a large rate cut.

In an article published a day later, on September 12, The Wall Street Journal reporter Nick Timiraos, who is widely seen as a “Fed insider,” wrote that the size of the Fed’s rate cut at the September meeting will be a close call. Additionally, the annual producer inflation, as measured by the change in the Producer Price Index (PPI), declined to 1.7% in August from 2.1% a month before. Markets shifted their view toward a 50 bps cut, which caused the US Dollar to come under renewed selling pressure.

Previewing the Fed meeting, “the FOMC is widely expected to start its easing cycle next week, with the Committee reducing rates by 25bp. The decision to cut between 25bp vs 50bp will be close,” TD Securities analysts said in a recently published report and added:

“In our view, the dot plot will be the most prominent part of the Fed's guidance next week, along with Chair Powell's post-meeting presser. We expect the Fed's forward guidance to lean broadly dovish.”

Dot Plot FAQs

What is the Federal Reserve “Dot Plot”?

The “Dot Plot” is the popular name of the interest-rate projections by the Federal Open Market Committee (FOMC) of the US Federal Reserve (Fed), which implements monetary policy. These are published in the Summary of Economic Projections, a report in which FOMC members also release their individual projections on economic growth, the unemployment rate and inflation for the current year and the next few ones. The document consists of a chart plotting interest-rate projections, with each FOMC member’s forecast represented by a dot. The Fed also adds a table summarizing the range of forecasts and the median for each indicator. This makes it easier for market participants to see how policymakers expect the US economy to perform in the near, medium and long term.

When does the Federal Reserve publish the “Dot Plot”?

The US Federal Reserve publishes the “Dot Plot” once every other meeting, or in four of the eight yearly scheduled meetings. The Summary of Economic Projections report is published along with the monetary policy decision.

Why is the “Dot Plot” important for markets?

The “Dot Plot” gives a comprehensive insight into the expectations from Federal Reserve (Fed) policymakers. As projections reflect each official’s projection for interest rates at the end of each year, it is considered a key forward-looking indicator. By looking at the “Dot Plot” and comparing the data to current interest-rate levels, market participants can see where policymakers expect rates to head to and the overall direction of monetary policy. As projections are released quarterly, the “Dot Plot” is widely used as a guide to figure out the terminal rate and the possible timing of a policy pivot.

How does data in the “Dot Plot” affect the US Dollar?

The most market-moving data in the “Dot Plot” is the projection of the federal funds rate. Any change compared with previous projections is likely to influence the US Dollar (USD) valuation. Generally, if the “Dot Plot” shows that policymakers expect higher interest rates in the near term, this tends to be bullish for USD. Likewise, if projections point to lower rates ahead, the USD is likely to weaken.

When will the Fed announce its interest rate decision and how could it affect EUR/USD?

The US Federal Reserve is scheduled to announce its interest rate decision and publish the monetary policy statement alongside the SEP on Wednesday, September 18, at 18:00 GMT. This will be followed by Fed Chairman Jerome Powell's press conference starting at 18:30 GMT.

The interest rate decision is likely to trigger the immediate market reaction. A 25 bps rate cut is likely to provide a boost to the USD, while a 50 bps reduction would have the opposite effect on the currency’s valuation. Following a knee-jerk reaction, the revised SEP could have a more lasting impact on the USD.

June’s dot-lot showed that 4 of 19 officials saw no rate cuts in 2024, 7 projected a 25 bps rate reduction, while 8 marked down a 50 bps cut in the policy rate. In case the new dot-plot shows that policymakers see the policy rate 100 bps below the current rate of 5.25%-5.5% at the end of the year, the USD could still come under pressure even if the Fed opts for a 25 bps cut because that would imply three consecutive rate reductions in the last three meetings of the year, including September, and one of them being a 50 bps cut. If the Fed opts for a 25 bps cut and the dot-plot points to two more 25 bps cuts in November and December, the USD could gather further strength.

Investors will also pay close attention to comments from Chair Powell in the post-meeting press conference. In case the Fed goes for a 25 bps cut but Powell says in the presser that it was a close call with some policymakers arguing in favor of a large cut, the USD could struggle to preserve its strength. Powell’s remarks on the growth outlook could also influence the risk perception and the USD’s performance. If Powell adopts a pessimistic tone about the economic outlook and notes a risk of recession, risk-off flows could dominate the markets. In this scenario, the USD is likely to find demand as a safe haven.

In summary, the September Fed event will have too many moving parts and surely ramp up market volatility. It could be too risky for investors to take large positions in the immediate aftermath of the Fed and they could opt to wait until the dust settles.

Eren Sengezer, European Session Lead Analyst at FXStreet, provides a short-term technical outlook for EUR/USD:

“Following the pullback seen in the first half of September, EUR/USD has turned bullish, with the Relative Strength Index (RSI) on the daily chart rising toward 60. Additionally, the pair recovered back above the 20-day Simple Moving Average (SMA) after closing below it for five consecutive days, reflecting growing buyer interest.”

On the upside, 1.1200 (static level, end-point of July-August uptrend) aligns as the first resistance before 1.1275 (July 18, 2023, high) and 1.1360 (static level from January 2022). In case the pair returns below 1.1090-1.1080 (20-day SMA, Fibonacci 23.6% retracement) and starts using this area as resistance, technical sellers could take action. In this scenario, the next support could be spotted at 1.1000-1.0980 (Fibonacci 38.2% retracement, 50-day SMA) before 1.0940 (Fibonacci 50% retracement).

US Dollar FAQs

What is the US Dollar?

The US Dollar (USD) is the official currency of the United States of America, and the ‘de facto’ currency of a significant number of other countries where it is found in circulation alongside local notes. It is the most heavily traded currency in the world, accounting for over 88% of all global foreign exchange turnover, or an average of $6.6 trillion in transactions per day, according to data from 2022. Following the second world war, the USD took over from the British Pound as the world’s reserve currency. For most of its history, the US Dollar was backed by Gold, until the Bretton Woods Agreement in 1971 when the Gold Standard went away.

How do the decisions of the Federal Reserve impact the US Dollar?

The most important single factor impacting on the value of the US Dollar is monetary policy, which is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability (control inflation) and foster full employment. Its primary tool to achieve these two goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the Fed’s 2% target, the Fed will raise rates, which helps the USD value. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates, which weighs on the Greenback.

What is Quantitative Easing and how does it influence the US Dollar?

In extreme situations, the Federal Reserve can also print more Dollars and enact quantitative easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used when credit has dried up because banks will not lend to each other (out of the fear of counterparty default). It is a last resort when simply lowering interest rates is unlikely to achieve the necessary result. It was the Fed’s weapon of choice to combat the credit crunch that occurred during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy US government bonds predominantly from financial institutions. QE usually leads to a weaker US Dollar.

What is Quantitative Tightening and how does it influence the US Dollar?

Quantitative tightening (QT) is the reverse process whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing in new purchases. It is usually positive for the US Dollar.