Brazil's Central Bank Set to Begin Easing Cycle as FX Markets Shift Focus from US Debt Downgrade

FX Daily: Brazil set to start its easing cycle

Markets were taken aback by Fitch's downgrade of US debt yesterday. EUR/USD rose, but the greenback is enjoying safe-haven demand to the detriment of high-beta currencies. We doubt this will be a long-lasting driver for FX markets and the focus will rapidly shift back to data. In Brazil, the central bank should start cutting rates today: we expect 25bp.

 

USD: Downgrade unlikely to be long-lasting driver

The dollar resilience was untouched by the soft block of data released yesterday, where the ISM manufacturing rebounded less than expected and remained quite deep in contractionary territory, and JOLTS figures showed a bigger than anticipated drop in job openings. Markets are clearly turning a blind eye to second-tier activity figures, and expectations that jobs figures will still be robust this week likely prevented any further dovish repricing in the USD curve, and left other factors (mostly weak data from China) to keep the dollar supported.

A surprise development that shook FX markets late in the US session yesterday was the announcement that Fitch downgraded the US from AAA to AA+, with a stable outlook. Fitch mentions the fiscal deterioration over “the next three” years and elevated government debt as the main reasons for the downgrade, which is the first one since 1994. This puts the US fiscal discussion back in scope for investors after the debt ceiling saga was quickly put on the back burner. EUR/USD jumped on the news, but high-beta currencies suffered, and the dollar seems to have been shielded by safe-haven demand.

Will this prove to be a driver for the FX market beyond the knee-jerk reaction? We doubt that. Treasury Secretary Janet Yellen described the downgrade as “outdated”, and markets will likely see it in a similar way (i.e. strictly tied to the debt ceiling standoff) especially in a week full of important data releases and with the next Federal Reserve rate hike hanging in the balance. Today, the ADP employment figures are the key highlight on the data front. In July, ADP figures more than doubled consensus estimates (almost 500k) but the official payroll print was a more modest 209k.