Standard Chartered: Will A Renewed Fed ‘Put’ Take USD Lower?

Standard Chartered write “the Fed put may be back. The Fed put exists when the market expects a rapid monetary policy response to any sign of economic weakness, but it has never, in our view, reflected any true love of the Fed for equities and other risky assets. It captures a market assessment that a negative shock will lead to sharp monetary policy easing. The result is a flatter yield curve and robust equity market performance.”

• “The flatter yield curve reflects the weighted average of two scenarios. The baseline scenario is the steady-as-you-go, soft-landing, slow-easing of policy rates that is now the market consensus. But the dominant risk scenario is that inflation falls faster than expected and the Fed eases more aggressively. The consensus soft landing is perfectly fine from a market risk perspective. The risk scenario of faster slowing of inflation or activity and steeper policy easing is not so bad either. The scenario that plays out matters for fixed income and money market pricing, but both support equities.”
• “The USD response is ambiguous. The USD is likely to fall if weaker-than-expected activity and inflation lead the Fed to exercise its put. Nominal and quite possibly real yields would likely decline sharply.”
• “But the consensus soft landing also entails Fed policy rate cuts. Steady activity could lower expected economic and asset price volatility. Even if money market yields back up a bit on the consensus soft-landing scenario, we are unlikely to see the full-scale USD strength of late 2021 and 2022 that was driven by the Fed’s no-compromise anti-inflation stance and accompanied by a 30% S&P drop.”