Next Interest Rate Decision
What to expect?
Dear Investors and traders,
I want to thank you for the latest support we have been getting. This weekend we will also share another trade ideas piece, but for today we have this short primer regarding the upcoming interest rate decision.
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Introduction
November has been an interesting month in the markets, with some big moves and clear signs that things might be shifting. The U.S. Dollar had its ups and downs, while traders closely watched what the Fed might do next. December is usually a strong month for the markets, so there’s plenty of hope for a good finish to the year.
Today, we’ll look at a few key charts to see what they tell us about the current market setup. From the U.S. Dollar to interest rate expectations, these charts give us a better sense of how traders are preparing for what’s ahead.
U.S. Dollar Index, Emerging Market Currencies, and FX Volatility
Let’s start with the U.S. Dollar Index (DXY) in the first chart below. After a strong comeback earlier this year, the dollar has recently taken a step back, currently sitting at around 106. This is happening because the market still maintains the belief that the FED will start a gradual decrease in the interest rate. Inflation has started to cool off, and while the economy is still strong, it’s not running as hot as earlier in the year, and we are starting to see slight weaknesses. As a result, the dollar isn’t getting as much support from rate hikes as it used to. It should also be mentioned that the dollar has strengthened since September due to escalations in the Middle East.
Next, the chart below shows various future FX contracts (with the USD being the proxy here). For example, we can see how the Mexican Peso futures and other emerging market currencies are doing against the dollar. These currencies tend to do better when the Fed is less aggressive because lower U.S. rates mean money often flows into riskier markets with higher returns. However, the December peso contract (6CZ2024) has been weaker than others, down 1.05%. This mixed performance shows that while there’s potential for emerging markets to benefit, some traders are still cautious due to local risks, like changes in oil prices or domestic policies.
Now, looking at the FX Volatility Index in the fifth chart, we see how stable or shaky different currencies have been. Volatility in the pound and yen remains high, reflecting uncertainty about their central banks. For example, the Bank of England is still fighting inflation, and the Bank of Japan is slowly moving away from its super-low interest rates. Meanwhile, other currencies have lower volatility, which shows traders are taking a wait-and-see approach with the dollar as they wait for clearer signals from the Fed.
Overall, these three charts tell us that the dollar could weaken further if the Fed slows down on rate hikes. Emerging markets may gain in that scenario, though traders remain watchful of risks. Volatility in some currencies reminds us that not all central banks are on the same path as the Fed.
SOFR Futures and Fed Rate Probabilities
When we talk about the FED, we should always look at SOFR futures, which gives us a clue about where interest rates might be headed. The upward trend in the curve shows that traders expect rates to come down over the next few years. For example, the December 2026 contract is pricing at much lower rates (approximately 3.6%) compared to where we are now. Recent data, like weaker-than-expected manufacturing and job numbers, has strengthened this belief that the Fed will enforce a gradual rate cut schedule for the foreseeable future.
This ties in with the Fed rate probabilities chart in the third image. Right now, CME Group estimates that there’s an 87.3% chance that the Fed will lower rates to 425-450 bps at the December 2024 meeting, compared to the current range of 450-475 bps. That’s a big change from earlier, as the estimate was 66% just a week ago.
The numbers and charts we see here highlight the growing confidence that the market is currently all-in on the narrative that the Fed will focus on keeping the economy steady while staying true to their target inflation rate of 2% through incremental rate cuts. Lower rates would likely boost stocks and other risk assets, especially those that are sensitive to interest rates. However, this depends on the Fed not being surprised by unexpected inflation or other shocks.
Conclusion
The charts presented give us a clear picture of what’s happening in the markets. The U.S. Dollar is losing some steam as traders prepare for a less aggressive Fed. Emerging markets could benefit, but risks remain. Volatility in some currencies reflects how global central banks are at different stages in their policies. On the other hand, SOFR futures and Fed rate probabilities show that markets are betting on lower rates again in December 2024, into 2025, and 2026, which could create opportunities for riskier assets.
Much will depend on how upcoming economic data plays out as we move through December. Markets might rally if the numbers keep pointing to a slowing but steady economy. But surprises could still throw things off course. For now, though, the signs suggest the Fed is leaning toward a softer approach, and that’s something the markets are already preparing for.
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In the meantime, get ready for the holidays!