The FX Trader: USD knee jerks stronger on first Warsh-led FOMC.

The latest

The FOMC takeaway was quick and sharp as the elimination of the “easing bias” (and all bias) in the new and stripped-down monetary policy statement by itself was hawkish. The statement itself observed that the economy is doing well, despite the uncertainties from the “Middle East”. The accompanying SEP economic projections of much higher core and headline inflation and a +0.4% bump in the median Fed rate forecast for this year relative to the March forecast, and +0.6% bump for next year also read as hawkish. Of course, with new Fed Chair Warsh setting in motion a task force to overhaul the Fed’s communication strategy and with his specific distaste for forward guidance of the Fed’s intentions, we may have seen our last, or  penultimate, dot plot and staff economic projections. And good riddance!

Warsh’s observations on the trouble with forward guidance were the best part of the press conference: “I think financial markets perform best when they react to incoming data. I think the financial markets work less efficiently when they ask a question, how will the Federal Reserve react to that incoming information..... Financial market prices are probably the most important source of information to guide central bankers. But when all the financial markets are doing is reflecting back what we’ve said, we’re taking the most important source of information and we’re being blind to it.” Amen!

All in all, Warsh is a charismatic speaker and looks like a strong leader at the Fed – making a forceful comment on wanting to fight inflation without providing any guidance for what that means and setting in motion no fewer than five task forces on everything from the Fed’s communication strategy (fully expected) to its balance sheet policy, productivity and the labor market, inflation measures (highly needed!) and other economic data. It will be interesting to see how much he can corral the political energy and the outspokenness of some Fed members, particularly on the board, but also at the margin with characters like the Minneapolis Fed’s Kashkari. As well, Warsh’s ability to maneuver in policy terms will be constrained by the heavy presence of skyrocketing debt servicing costs for the treasury market and the risk that Bessent reaches out a heavy hand to force the Fed into supportive mode on that front.

For now, the US dollar is rallying as US 2-year treasuries are hitting new cycle highs on rising expectations for Fed rate hikes. A September FOMC hike is seen as nearly a sure thing, with about two hikes priced in now by March of next year. I’m not nearly as convinced that these are coming as the market. Warsh noted the risks of uneven policy transmission (pulling out housing as something where conditions look tight, for example). And the incredible AI cap-ex effect may be cresting in the months ahead. Interesting to note that 30-year treasury yields are now lower than they were before the FOMC. Is this due to the unwind of yield steepening bets, Warsh credibility meaning that this Fed’s hawkishness will help beat inflation and slow growth? Not sure, but that long yield effect may be the driver of the JPY outperforming the euro and other currencies here as the USD has risen. (Some might say the threat of MoF intervention is a more important factor – we’ll need some more evidence, for now, let’s just point out that the JPY cross correction is worth tracking).

Chart focus: EURUSD
After its recent reversal negated the prior breakdown, EURUSD is at it again to the downside, breaking down through the recent 1.1500 low in the wake of the FOMC meeting as the market adjusts its expectations for Fed tightening higher for this year. The next focus is the 1.1411 range low from back in March when the market was reeling from the Iran war situation. Much bigger picture, the more structural area of interest is down in the 1.1200-1.1250 area that capped EURUSD in 2023 and 2024. Technically, bears are in charge here unless we see a sharp reversal of this post-FOMC move.