Head of FX Strategy
Summary: Rates markets suggested that there was little new in the way of guidance from Fed Chair Powell’s speech at Jackson Hole, but the US dollar ripped higher as the backdrop remains the same: this Fed has confirmed that it will continue tightening until something breaks, so what we are seeing is the further progress toward that breaking point. In an interesting twist, a paper delivered on Saturday at Jackson Hole suggests that the Fed may have a hard time executing shrinking its balance sheet as intended.
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 13th 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.
For Europe, any little helps, and we have natural gas prices backing off sharply today, with Germany ahead of target in rebuilding its storage and the German economy minister called for an overhaul of the EU power market to drop prices (meaning rationing and price fixing?? In the first instance, helps to ease the shock, but not in the longer run if investment in the capacity needed to bring long term real energy prices down is scared away by the risk of public interference.) Elsewhere, besides natural gas prices coming off, we have also seen a few ECB officials talking tough enough to pull ECB yield expectations sharply higher since Friday, with the ECB’s Isabel Schnabel speaking at the Fed’s Jackson Hole conference at the weekend, exhorting her colleagues “to signal their strong determination to bring inflation back to target quickly.” The meeting next Thursday is priced for over 60 basis points, with almost another 100 basis points (!) on top of that priced through the December ECB meeting. ECB Chief Economist Lane, usually one of the more cautious voices on the ECB, will speak this afternoon.
Table: FX Board of G10 and CNH trend evolution and strength.
USD strongest among G-10 currencies – no surprise there, but really needs to stick this move to remain so across the board (below parity in EURUSD, above 137.50 in USDJPY, above 1.3000 in USDCAD, below perhaps 0.6900 in AUDUSD, etc… Note the big swing higher in EUR momentum, with a few thoughts on individual EUR pairs below.
Table: FX Board Trend Scoreboard for individual pairs.
EURCAD and EURAUD are two euro crosses that have turned sharply higher as risk sentiment wears harder on the smaller currencies – too early to tell if this is the beginning of something, but the moves come at interesting levels. Note Also EURGBP following through higher Friday and following through today.
Upcoming Economic Calendar Highlights (all times GMT)
Bond. Long Bond(s)
With real rates being too positive, we see three scenarios: Opportunity to lock in rates at cycle high, government overreach to keep the economy afloat or a complete reset of the economy.
Steen Jakobsen,
Chief Investment Officer
Is a bond bull market ahead? Inflation still poses a risk for investors, but the moment for increasing duration to your portfolio may be approaching towards the end of the year, when central banks might be forced to cut interest rates.
Althea Spinozzi,
Senior Fixed Income Strategist
The furious rate hike cycle has brought gains in the US dollar, but with stagflation risks in Europe and the UK and weakness in the Chinese economy, USD may have more room to run. But a strong dollar could also have repercussions for US growth, emerging markets and commodity prices.
Charu Chanana,
Market Strategist
With the cost of capital rising painfully, stagflation fears are back, illuminating the fragile state of the green transformation, while giving a tailwind to nuclear power, and threatening the growth of AI-related stocks.
Peter Garnry,
Head of Equity Strategy
With supply tightness not only in energy but all commodities, the momentum in commodity prices may continue, pressuring central banks to lower real rates. That could be a good setup for precious metals, including gold, silver and potentially platinum as well.
Ole S. Hansen,
Head of Commodity Strategy
As the pandemic showed, even the US Treasury can experience seismic shifts. With the government increasing the pace of issuing bonds to support fiscal spending, the complex Treasury market and regulatory constraints could spark a liquidity event.
Redmond Wong,
Market Strategist
The tide has turned for bonds. Given the current yields, bonds have become an attractive investment, with added benefits including lower risk than stocks, increased diversification and a steady stream of income unaffected by economic changes.
Peter Siks,
Investment Coach
