Synopsis:

Danske Bank believes the market is overly optimistic regarding the extent of Federal Reserve rate cuts anticipated for the near term. Despite the Fed's dovish signals, Danske maintains a more conservative forecast and sees potential downside for EUR/USD.

Key Points:

1. Fed's July Meeting Outcome:

   • No Policy Changes: As widely expected, the Fed made no changes to its monetary policy.
   • Rate Cut Signals: Fed Chair Jerome Powell did not pre-commit to rate cuts but indicated that cuts could start as early as September.

2. Market Expectations and Fed's Stance:

   • Scenarios Considered by the Fed: Powell mentioned plausible scenarios ranging from 'zero to several cuts this year,' focusing on potential sharp deterioration in labor market conditions, though no immediate panic is warranted.
   • Current Market Pricing: Markets are currently pricing a 10-15% probability for a 50 basis points cut in September and a cumulative 72 basis points of cuts by year-end.

3. Danske's Forecast:

   • Moderate Rate Cuts Expected: Danske expects only quarterly 25 basis point reductions starting in September, significantly less aggressive than the market's pricing.
   • EUR/USD Outlook: The dovish signals from Powell at the press conference initially caused EUR/USD to move lower, but the pair later reversed part of this decline. Danske sees potential downside for EUR/USD given the current market expectations.

4. Market Reactions:

   • US Treasury Curve: The Treasury curve bull-steepened, with the 10-year yield declining by 6 basis points to a new 5-month low of 4.07%.
   • Risk Tilt: Danske believes the current Fed pricing is optimistic, with risks related to US rates now strongly tilted to the upside.

Conclusion:

Danske Bank considers the current market pricing of aggressive Fed rate cuts as excessive. They maintain a more conservative forecast of quarterly 25 basis point reductions starting in September and anticipate downside potential for EUR/USD. This perspective is based on the Fed's cautious approach and the actual economic data, particularly labor market conditions, which do not yet justify panic.