The US economy continues to surprise on the upside with its economic data releases. An uptick in inflation in October is another reason why the Fed has little reason to rush into further rate cuts. Having already eased monetary policy by cutting rates from a peak of 5.5%, the pace of further monetary policy easing is likely to slow. Using a natural language-processing algorithm that looks at Fed officials’ statements and separates them into hawkish and dovish dimensions, the Fed became more hawkish last week. Stronger-than-expected retail sales data contributed to the more hawkish stance, as did higher inflation. 

The October inflation report was fully in line with market expectations, with higher inflation due to base effects, and did not signal a further cooling of inflation, nor did it show an acceleration of inflation. As the decline in inflation stalls, the urgency of lowering the federal funds target rate is diminishing, and attention is shifting even more to the labour market and overall economic activity.

The upcoming policy change under President-elect Trump is likely another reason for the more hawkish tone, suggesting that there will be few additional rate cuts and that the Fed may choose to pause at its next Federal Open Market Committee meeting in December. We are becoming increasingly confident about our forecast that the Fed will lower the target for the federal funds rate to a range of 4.25%–4.00% by March 2025 and maintain a moderately restrictive stance thereafter.

Currencies: A domino effect for the US dollar and Swiss franc

In the wake of the US elections, the US dollar has continued to strengthen. With President-elect Donald Trump in the sweet spot, showing decisiveness to follow through with his policy agenda, investors have been jumping on the Trump reflation trade. The Fed’s reduced urgency to cut rates, as mentioned above, is a further driver. At the same time, the euro contrasts not only with a bleak eurozone growth backdrop and an increased risk of tariffs on European exports but also with the German political crisis. 

Therefore, the US dollar could well extend its positive momentum in the near future. Accordingly, we have revised our 3-month EUR/USD target to 1.05. Dollar strength may only come to an end when the conviction in reflation begins to fade. High interest rates that eventually become a growth burden could be a potential trigger. Hence, we remain sceptical about the durability of US dollar strength in the longer term and stick to our view of the dollar staying in its trading range.

Beyond that, we identify potential downside risks due to Trump’s policies, which could result in a rising budget deficit and higher public levels, increased economic policy uncertainty or unpredictability, and potential tampering with central bank independence. Investors could demand more risk compensation and eventually hold back from investing into US government debt.

The Swiss franc has also benefited from the eurozone’s issues and strengthened to levels of EUR/CHF 0.93, but further upside appears limited, as the Swiss National Bank could intervene. Meanwhile, further policy rate cuts in Switzerland are keeping the franc’s interest rate disadvantage ample and rendering the franc into a potential carry-trade-funding currency. We have revised our EUR/CHF 3-month forecast up to 0.94 but refrain from seeing a significantly stronger franc and thus stick to our 12-month forecast of 0.97.

What does this mean for investors?

The US economy is surprising with positive data, which reduces the need for interest rate cuts. The decline in inflation has stalled, and now the focus is on the labour market. We expect fewer interest rate cuts, and possibly also a pause in December. Our forecast expects the Fed to lower the target for the federal funds rate to a range of 4.25%–4.00% by March 2025.

We have upgraded the USD forecast given the political agenda and the continuously supportive macroeconomic numbers coming out of the US. The showdown between the new government and the US Federal Reserve may be further down the road than many think, for the heavy lifting in US sovereign debt issuance may only come after the summer break in 2025.