The Fed surprised the markets by delivering a more cautious assessment of the longer-term US economic and inflation outlook and much lower glide path for policy rates. The changes were driven by the latest China-induced market selloff that triggered unwarranted tightening in the global financial conditions. CA economists maintained their call for lift-off in October after the meeting.
That said, the dovish Fed message and the fact that risks to global growth and inflation remain largely unresolved highlights the risk that rates may remain low for longer. The USD lost ground broadly while risk appetite recovered in the wake of the September meeting. The question for many is whether this is the end of the decoupling trade and the recent risk aversion.
In our view, the September meeting was a setback for the USD-bulls but it changed little in terms of the relative policy outlook between the Fed and other central banks. Indeed, the Fed inaction could soon spur the ECB and the BoJ into action as they try to lean against FX appreciation. This should keep risks for EUR and JPY to the downside against USD.
In addition, the Fed was more dovish because of concerns about global growth and inflation. This is not an environment that should encourage risk taking. With China still casting a long shadow over the markets, any risk rebound is likely to be short-lived. We therefore maintain a cautious view on the G10 commodity and risk-correlated currencies.
Last but not least, GBP could be the unlikely winner of the latest developments with the BoE still the only major central banks that is sending a fairly clear signal that rates will be heading higher before long.
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