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TD Securities: The Market's Getting Fed Rates Wrong, and the Dollar Will Pay
The Federal Reserve meets Wednesday, and the market has already priced in hawkish fireworks. TD Securities thinks that's a mistake worth betting against.
Currency strategists at the bank are positioning for a U.S. dollar decline if, when, they argue, the Fed holds rates steady this week. The logic: traders have overshot. They've baked in expectations the central bank won't deliver, and when reality lands softer than the priced-in posture, the greenback takes the hit.
The current Fed funds rate sits at 5.25% to 5.50%, a range the Fed has held since mid-2025. Market pricing suggested another quarter-point hike was possible, or at minimum, rhetoric aggressive enough to keep the door open. TD's view is that neither is coming. Inflation has cooled. Core PCE, the Fed's preferred gauge, printed at 2.4% in June. The labour market is no longer tight, it's loose. Job openings per unemployed worker dropped to 1.1 in the latest JOLTS report, the lowest since early 2021. The data doesn't support another hike. It barely supports holding this long.
Why the Market Mispriced This
Part of the mispricing comes from recency bias. The Fed spent 2024 in damage-control mode, raising rates faster than any cycle since the early 1980s. That leaves a hangover. Traders assume the default stance is hawkish until proven otherwise. But the Fed's own dot plot from June showed the median member forecasting cuts by year-end. The market ignored that. It priced for posturing instead of policy.
The other part is the USD's safe-haven premium. Geopolitical noise, tensions in Eastern Europe, trade friction with China, instability in the Middle East, has kept capital flowing into dollar-denominated assets. That's real. But it's also temporary. When the catalyst shifts from "where is safe" to "where is yield," a Fed on hold while the European Central Bank and Bank of England cut more slowly creates a narrowing rate differential. The USD loses its carry advantage.
For Canadian investors, a weaker USD means a stronger loonie, which cuts both ways. A rising CAD lowers import costs, beneficial for inflation, and gives the Bank of Canada room to ease without worrying about imported price pressure. But it also makes Canadian exports less competitive. A Manitoba wheat farmer selling into U.S. markets takes an immediate margin hit when the exchange rate moves from $0.72 to $0.75 USD.
The Lag Nobody Talks About
Rate decisions take 12 to 18 months to filter through. The hikes the Fed made in 2024 are still working. Housing starts in the U.S. are down 22% year-over-year. Commercial real estate refinancing has stalled. Credit card delinquencies are climbing. The effects are baked in. Holding rates here for another six months doesn't keep policy tight, it extends tightness that's already choking parts of the economy.
The TD call isn't a macro forecast. It's a positioning trade. If the Fed holds and sounds neutral, the dollar sells off because the market was positioned for something tougher. If the Fed cuts, the dollar sells off harder. The only scenario where TD is wrong is if Jerome Powell delivers a hold with language aggressive enough to reanchor hawkish expectations. That would require ignoring the data entirely.
Currency markets move on expectations, not outcomes. When expectations overshoot, the snap-back is sharp. TD is betting the snap happens this week. The dollar, they argue, is priced for a Fed that no longer exists.
The Federal Reserve meets Wednesday, and the market has already priced in hawkish fireworks. TD Securities thinks that's a mistake worth betting against.
Currency strategists at the bank are positioning for a U.S. dollar decline if, when, they argue, the Fed holds rates steady this week. The logic: traders have overshot. They've baked in expectations the central bank won't deliver, and when reality lands softer than the priced-in posture, the greenback takes the hit.
The current Fed funds rate sits at 5.25% to 5.50%, a range the Fed has held since mid-2025. Market pricing suggested another quarter-point hike was possible, or at minimum, rhetoric aggressive enough to keep the door open. TD's view is that neither is coming. Inflation has cooled. Core PCE, the Fed's preferred gauge, printed at 2.4% in June. The labour market is no longer tight, it's loose. Job openings per unemployed worker dropped to 1.1 in the latest JOLTS report, the lowest since early 2021. The data doesn't support another hike. It barely supports holding this long.
Why the Market Mispriced This
Part of the mispricing comes from recency bias. The Fed spent 2024 in damage-control mode, raising rates faster than any cycle since the early 1980s. That leaves a hangover. Traders assume the default stance is hawkish until proven otherwise. But the Fed's own dot plot from June showed the median member forecasting cuts by year-end. The market ignored that. It priced for posturing instead of policy.
The other part is the USD's safe-haven premium. Geopolitical noise, tensions in Eastern Europe, trade friction with China, instability in the Middle East, has kept capital flowing into dollar-denominated assets. That's real. But it's also temporary. When the catalyst shifts from "where is safe" to "where is yield," a Fed on hold while the European Central Bank and Bank of England cut more slowly creates a narrowing rate differential. The USD loses its carry advantage.
For Canadian investors, a weaker USD means a stronger loonie, which cuts both ways. A rising CAD lowers import costs, beneficial for inflation, and gives the Bank of Canada room to ease without worrying about imported price pressure. But it also makes Canadian exports less competitive. A Manitoba wheat farmer selling into U.S. markets takes an immediate margin hit when the exchange rate moves from $0.72 to $0.75 USD.
The Lag Nobody Talks About
Rate decisions take 12 to 18 months to filter through. The hikes the Fed made in 2024 are still working. Housing starts in the U.S. are down 22% year-over-year. Commercial real estate refinancing has stalled. Credit card delinquencies are climbing. The effects are baked in. Holding rates here for another six months doesn't keep policy tight, it extends tightness that's already choking parts of the economy.
The TD call isn't a macro forecast. It's a positioning trade. If the Fed holds and sounds neutral, the dollar sells off because the market was positioned for something tougher. If the Fed cuts, the dollar sells off harder. The only scenario where TD is wrong is if Jerome Powell delivers a hold with language aggressive enough to reanchor hawkish expectations. That would require ignoring the data entirely.
Currency markets move on expectations, not outcomes. When expectations overshoot, the snap-back is sharp. TD is betting the snap happens this week. The dollar, they argue, is priced for a Fed that no longer exists.
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