Dollar Continues to Fall Ahead of Fed Meeting

The U.S. dollar declined on Tuesday and was trading near its lowest levels of the year amid growing expectations that the Federal Reserve will cut interest rates this week, likely by a significant margin.

Fed Meeting Begins

The Federal Reserve begins its latest policy-setting meeting later in the session amid growing expectations that the Fed will cut interest rates by 50 basis points by the end of the meeting on Wednesday.

According to CME FedWatch, traders are pricing in a 68% chance of a 50 basis point cut and a 32% chance of a 25 basis point cut.

“Markets have continued to consolidate their bearish positions in the dollar ahead of tomorrow’s FOMC announcement,” ING analysts said in a note. “These currency dynamics are a direct consequence of the continued repricing of rate expectations, with the swap market now attributing around 70% implied probability (43 basis points) to a 50 basis point cut tomorrow.”

Tuesday’s economic data includes the release of the latest U.S. retail sales figures, which are expected to have contracted month-on-month in August, potentially adding further weight to the idea of a 50 basis point cut.

Euro Has the Potential to Gain More in Recession – BNP Paribas

In Europe, EUR/USD rose about 0.1% to 1.1136, settling not far from the year’s high of 1.1200, despite the European Central Bank cutting interest rates by 25 basis points last week for the second time this year.

Germany’s ZEW economic confidence survey will also be released later in the session today, and is expected to indicate a slight deterioration this month, as conditions in the eurozone’s largest economy continue to be difficult.

According to analysts at BNP Paribas (BNPQY), in a note, the euro could continue to rise against the dollar even if a global economic recession sets in.

The French bank cites the fact that the dollar has recently been used as a high-yielding currency, which historically has not been the case, making it more vulnerable to declines as U.S. interest rates fall.

Another factor is that the Fed has raised rates above its neutral level more than many other central banks. As a result, euro spreads and peripheral currency bloc government bonds have become less sensitive to periods of risk aversion, which is a positive for the euro.

GBP/USD was down slightly to 1.3213, despite sterling being the best-performing G10 currency this year, up 3.9% against the dollar.

The Bank of England meets on Thursday and is expected to keep its policy rate unchanged at 5% after beginning its easing with a 25 basis point cut in August.

The Yen, Awaiting the Bank of Japan’s Meeting

The yen fell 0.1% against the dollar to 140.50, close to its lowest levels of the year.

The yen was supported by expectations of a U.S. interest rate cut, as traders were seen building long positions in the yen ahead of the Bank of Japan’s meeting this Friday.

Analysts do not believe that the Bank of Japan will raise interest rates. However, policymakers are expected to position themselves aggressively and anticipate a rate hike in the event of a pickup in inflation.

The USD/CNY pair remained largely unchanged at 7.0930, with local Chinese markets closed for the second session in a row. However, weak economic data over the weekend suggests further weakness in the yuan.