USD: Powell may not want to shock the markets (in either direction)
Fed Chair Jerome Powell will deliver his much-awaited keynote speech at the Jackson Hole Symposium at 1500 GMT today. Yesterday, comments by other Fed officials largely fell on the hawkish side of the spectrum. The arch-hawk James Bullard stressed once again the need for front-loading of rate hikes, suggesting rates should be raised to the 3.75-4.0% mark by the end of this year. The host of the Symposium, Kansas City Fed President Esther George, also said high inflation warrants more hikes, but highlighted the importance of incoming labour data (next week) to determine the size of September’s hike.
Markets will be scanning Powell’s speech today from a number of different perspectives: inflation, growth outlook, front-loading, and any hint of easing in 2023. All these factors can play a different role in driving the reaction in the FX market, although we see a quite elevated risk that Powell may end up broadly matching the generally hawkish market expectations and avert any significant market shock.
On the inflation side, the speech will take place shortly before the release of PCE inflation numbers for July, which are expected to have eased slightly but remain well above 6%. There’s simply not enough evidence or interest by the Fed to sound any less concerned on the inflation picture at this point, and a firm reiteration that additional forceful tightening to curb price pressures could remain at the core of Powell’s message today.
Our suspicion is also that today’s speech will keep the notion of data dependency well intact, and potentially put off a big chunk of what could have been today’s market reaction until next week when US jobs figures are released.
Looking at the implications for the dollar, we think that markets may find enough reason to push their peak rate pricing a bit closer to the 4.0% mark today and stir away from pricing back more than the current 1-2 rate cuts in 2023, which should ultimately offer some support to the dollar into next weeks’ payrolls release. We think DXY may touch 110.00 in the coming days, if not today.
Despite not being our baseline case, the downside risks to the dollar are non-negligible today. A more alarming tone on recession and any hints that the Fed will be more considerate when it comes to tightening to avert a major dampening impact on the economy would likely trigger an asymmetric negative reaction on the dollar, considering a rather stretched long positioning and short-term overvaluation, especially against European currencies.