The Fed minutes earlier this week showed that members remain more concerned about inflation risks than about labour market softening. Although the meeting took place just before the latest volatility around the August employment report, several policymakers reiterated a cautious stance toward immediate rate cuts. The doves are no longer certain that the Fed will cut rates in September. Market pricing now implies around a 75% probability of a 25bp cut, down from near certainty last week when some even considered 50bp cuts.
Inflation vs Jobs: a fine balance. The three-month average job gains in the US dropped from around 150K to just 35K, raising concerns that cracks are emerging in the US labour market following the August jobs report. The story has shifted from "the US job market remains resilient despite trade and AI risks" to "the Fed may be falling behind." On inflation, CPI data suggested consumer prices remain contained, but PPI reflected tariff-driven cost pressures. US retail earnings added nuance: consumers are shifting toward discount stores and smaller-ticket purchases. While overall demand appears intact, Walmart noted tariff-related pricing effects, restocking with higher-priced goods — a trend that could soon filter into CPI.
This leaves the Fed balancing competing priorities. On one side, the administration — including President Trump — has been pushing for lower rates to cushion the jobs impact of trade tensions. On the other, policymakers remain wary of stoking inflation amid tariff pass-throughs. In theory, inflation should take precedence, yet cracks in the jobs data complicate the picture.
That's why attention now turns to Powell's speech at Jackson Hole. While he may stick to a "data dependent" message, the venue has historically hosted major policy shifts. Markets are alert to any surprise, and there is a greater chance that we will see a hawkish surprise than the contrary.
A cautiously hawkish tone from Powell could further unwind the market's extra-dovish positioning. That could mean a rebound in US 2-year yields, pressure on the S&P 500, a stalling of the small-cap rally, and renewed strength in the US dollar. Rising global yields — notably in long-maturity JGBs — add to the risk of a broader selloff if Powell strikes a firmer line.
For now, USDJPY is stable, the dollar has firmed ahead of Powell's remarks, and EURUSD has slipped below its 50-day moving average. The pair looks heavy after this week's decline. Meanwhile, euro area manufacturing PMI printed above 50 for the first time in more than three years, driven by new orders — possibly reflecting easing trade uncertainty and tariff clarity. Progress in US–EU trade discussions and the expected boost from military spending also brighten Europe's growth outlook. That said, stronger activity could complicate the European Central Bank's (ECB) ability to justify further cuts. For now, the ECB is likely to sit out September, and possibly drop the idea of another cut, if tariff impacts prove less severe than feared.
The Stoxx 600 has erased tariff-led losses and is advancing toward new highs, making it a favoured vehicle for investors diversifying away from US tech. But the euro, which has gained on military spending narratives and broad dollar weakness, may be nearing a peak if US dollar demand revives this fall on a hawkish Fed turn. Powell's speech at Jackson Hole will be decisive — and markets will be listening closely.
