By John Hardy
The market tried to spin Powell’s Friday Jackson Hole speech as somewhat dovish, or at least non-hawkish, and risk appetite jumped higher. If we look at US short rates, however, the speech brought nothing new to the table to shift Federal Reserve rate hike anticipation.
That is precisely the message we should receive from the speech, which effectively saw Powell discussing how many of the tools, or “stars”, that are supposed to guide Fed policy have so often proved of very poor quality and still provide few answers on how close the dangers of accelerating inflation appear. In selling the US dollar, the market’s immediate reaction to the speech seemed to be the immediate focus on the portion of the speech declaring that the Fed doesn’t see any risk of an additional inflation pickup now that inflation has moved above the Fed’s 2% target.
On Friday, however, I highlighted the passage I found most interesting:
“Whatever the cause, in the run-up to the past two recessions, destabilising excesses appeared mainly in financial markets rather than in inflation. Thus, risk management suggests looking beyond inflation for signs of excesses.”
Powell is effectively saying that inflation is unlikely to prove a story in the near future, bolstering his argument with an extensive discussion of inflation expectations and how these have never become unanchored since the Great Inflation of the 1960s-70s. In other words, with inflation rising but benign and unemployment dropping but failing to trigger the inflation it was supposed to, Powell’s chief focus could be on the risks from financial stability.
On that note, aren’t the worst risks of the “excesses” Powell discusses those that have already built up in the years under his predecessors in the form of low quality corporate debt in the US and emerging market debt around the world? It feels to me like Powell is admitting between the lines that he will just see what happens and won’t reach as quickly or aggressively for the policy easing lever as former Fed heads, because the greatest risks from policy are encouraging financial instability.
This is hardly cause to put back on the Goldilocks trade.
As a side point, a good deal of the USD weakening in the wake of the speech was likely more down to China’s move Friday to reintroduce the “counter-cyclical factor” in setting the CNY level, a move it first made back in 2017 to stop the CNY devaluation at the time.
The economic calendar for the week ahead looks rather barren, with the most interesting tidbits coming up on Thursday with Germany’s flash August inflation reading and the latest July PCE inflation data out of the US. In the US, that Core PCE inflation rate is expected to edge higher to the 2.0% level, but given our discussion above on the Fed’s reactivity to inflation, the implications may be minimal unless we see a massive upside surprise. The Eurozone August flash CPI reading will be released Friday.
The EURJPY bounce has been rather profound but is looking overdone relative to the backdrop unless global markets are set to sustain a strong further rally driven by the Goldilocks trade. Note the overhead resistance in the form of the Ichimoku daily cloud; it's currently in the 130.00 area but looks set to drop in the days ahead (and then the 200-day moving average a bit higher still).
The G-10 rundown
USD – again, not seeing anything in Powell’s speech to deserve a sustained USD weakening, but if animal spirits feel comfortable with putting back on the Goldilocks trade (happy days for risk as the Fed outlook is not going anywhere and China is going to keep the CNY floor in place), then the USD weakness could extend a bit.
EUR – the rally looks over-enthusiastic at these levels but this latest rally in EURUSD has disrupted the bearish case even if the pair remains rangebound for now. Have a hard time conjuring positive catalysts for Europe at the moment, with the next test perhaps over Italy’s budget intentions in the coming weeks.
JPY – the yen has weakened as the EM currencies got a shot in the arm on China’s move to keep the floor under the renminbi and on the rebound in global risk appetite, led by Asia. The high beta for JPY is in the risk/JPY crosses. Would be surprised if the current risk rally can find legs beyond the near term, given uncertainties ahead.
GBP – sterling slipping to new lows versus the euro providing some ominous background music but at these levels above 0.9000 we may need to see real developments or signs that no-deal odds are escalating to continue to drive weakness.
CHF – EURCHF has rebounded in sympathy with the broadly stronger euro – will be surprised if 1.1500+ is achievable unless Italy’s yield spreads to the core are crushed as the populist government makes nice (not likely).
AUD – the Aussie recovering as a new prime minister named but more importantly on China’s move to shore up the renminbi, but the Aussie still looks like a weak link on long-term fundamentals, with short term upside risks on any sustained return of the Goldilocks trade and from the risk of a squeeze on the rather aggressive speculative short position.
CAD – a possible breakthrough on NAFTA on the way, but hard to detect this in USDCAD at the moment, which continues to find support ahead of the pivotal 1.3000 area. The latest Canada GDP figure is up on Thursday.
NZD – AUDNZD back below 1.1000 as bulls are left twisting in the wind. Still don’t like NZD as long as uber-dove Orr is at the helm of the RBNZ.
NOK – the krone’s travails are remarkable, given the rebound in risk appetite and a fresh surge in oil prices – have a hard time seeing why EURNOK should push any higher or have a go at 10.00, but the lack of a pulse in NOK given the backdrop is unsettling.
SEK – nerves clearly on show ahead of the September 9 election. Even if the centre barely holds, SEK may prove too cheap, as it is difficult to see how the election results in dramatic new policy swings that affect capital flows or the economy.