Our view for many months now has been that the Fed would start to cut rates in September. However, with the reduction in rates mirroring policy easing in the rest of G10 (barring Japan) we have not been predicting that Fed easing would unleash a tumble in the dollar.

In addition, the huge uncertainty around November’s presidential election was seen as another reason why traders and investors might be reticent to pile the pressure on the dollar ahead of the November 5th vote.

As a result, our view has been that the dollar would hold steady, not too far from a 1.05-1.10 range against the euro, through to the election and possibly beyond. But the Fed’s large rate cut, the Fed’s justifications for the big move, and the persistence of asset price strength all leave us wondering whether it is right to think that the dollar will prove pretty impervious to easier monetary policy, at least this side of the Presidential election.

We have concerns about the Fed’s rate cut on a number of levels. Firstly, it smacks of ‘catch-up’. Powell even noted in his press conference that the Fed has held rates while others have cut. That might have been good policymaking, but there could be a worry now that, if it is running to catch up with the others, the scale of future rate cuts could be large and pull the dollar down.

Another concern we have relates to the political angle. One reason that we held onto the view that the Fed would ease in September for many months, even as the market wobbled in the spring and early summer, was due to politics. We felt that, while the Fed is undoubtedly politically independent, with a big “P”, meaning that members will never express their political beliefs, or debate the impact of elections in their deliberations at the Fed, there may be a role for politics with a small “p”. What we mean by this is that members may vote in a way that partly reflects their own individual, never-confessed, concerns that a second Trump term could undermine democracy in the US. In our view, even politics with a small “p” could encroach on appropriate decision making by policymakers at the Fed.

A third issue that leaves a slightly bad taste in the mouth, and fearing for the US dollar, concerns the financial market backdrop against which this large rate cut has occurred. In the past, we have heard Powell talk a lot about “financial conditions.”. Earlier in the year, for instance, he spoke about tightening financial conditions in a way that’s sufficient to bring inflation to target. But, as far as we can tell, financial conditions have not tightened at all. Numerous indicators of financial conditions, such as the Chicago Fed’s National Financial Conditions index, have tumbled through most of 2023 and continued easing through this year. This suggests that the Fed may be playing fast and loose with inflation risks, given the large rate cut on Wednesday.

In addition, it has thrown fuel on the asset-price fire, and, the more riskier asset prices rise, the more safe assets – including the US dollar – may fall. Put another way, if the Fed had made a large rate cut in the teeth of collapsing financial asset prices we’d probably see the dollar rise. But rate cuts against the backdrop of robust financial market sentiment have the capacity to inflate the bubble a bit more, at a cost of a weaker US dollar.

The bottom line, at least for euro/US dollar is that the drift down to the 1.05 end of the range ahead of the November election that we had suggested now looks unlikely. Far more likely is that the dollar stays on the defensive and this might be most acute against the smaller ‘riskier’ G10 currencies such as the aussie and kiwi, or the Scandinavian currencies rather than the euro, Swiss franc and pound – provided risk sentiment stays buoyed by the Fed’s large rate cut, of course.