FX Update: Jackson Hole was more than Powell’s speech.

FX Trading focus: Jackson Hole wasn’t just Powell’s speech…

If we have a look at the reaction in Fed expectations from Friday’s Fed Chair Powell speech at Jackson Hole, there was no major market takeaway. During the speech, there was a trivial marking down of expectations as Chair Powell emphasized the “totality” of data in setting the appropriate rate at the September meeting. (And 90 minutes before his speech, the July PCE inflation data was out a tad softer than expected, while the final University of Michigan sentiment survey for August saw longer inflation expectations 0.1% lower). But for that September 21 FOMC rate decision, the payrolls and earnings data this Friday and the Sep 13^th CPI release will weigh more heavily.

Somewhat more importantly, Powell underlined the importance of ensuring that The Fed’s policy remains persistent enough to ensure that the inflationary cycle has abated. One of the key passages worth highlighting is “Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy.” Powell then went on to invoke Paul Volcker and his fight with recurring bouts of high inflation in the 1970’s and early 1980’s. This did see the market adjusting Fed rate expectations higher for mid next year and later, although that was largely reversed by the end of the day Friday on a (suggesting a difficult to manage reflexivity dissonance: more Fed tightening means worse financial conditions, which means the Fed might back off, which is supportive of financial conditions/sentiment? Argh…).

One very important factor to note is that Fed rate expectations were marked sharply higher from the outset overnight, perhaps as a paper delivered at Jackson Hole on Saturday that suggests that any Fed attempt to go full force with quantitative tightening will prove difficult (requiring an emphasis on using the Fed funds rate as the primary mechanism for policy adjustments?). A Bloomberg article discusses the paper. If the Fed has to soft-pedal balance sheet management from here, could we suddenly find that peak anticipated Fed tightening (QT and rate hikes taken in aggregate) is already in the rear view mirror? Intriguing proposition, but way too early hours/days to make any determination, as the Fed may try forging ahead on QT, paper or none.

Chart: USDJPY
Watching USDJPY closely this week to see if US data takes US treasury yields higher still – especially at the longer end of the US yield curve, which could serve to renew the pressure on the Bank of Japan as it insists on maintaining the yield-curve-control policy. Arguably, as long as the longer end of the US yield curve is anchored below the June highs, the pair doesn’t have particularly cause to run higher unless there is a USD liquidity problem not connected to yield volatility. And if we get weak US data this week through Friday’s jobs and earnings report, we might be instead looking at a “double top” scenario. The 139-140.00 zone looks important this week.