- Dollar rally based on little save short-term speculation
- Look for greenback rally to fade even if jobs data are strong
- Central banks 'losing what little mojo they have left'
Dollar bulls may have roared out of the gate following Fed chair Yellen's speech,
but the ride looks set to be short and bumpy. Photo: iStock
By John J Hardy
The US dollar snapped to attention and rallied hard into the close of last week’s trading after Federal Reserve chair Janet Yellen spoke at a central bank conference in Jackson Hole, Wyoming.
The move in the market was actually more notable than was justified by anything in Yellen's address. It was a surprise, in fact, that the Fed chief took the trouble to start with a number of comments on the US economy and the likelihood for further rate hikes amid expectation that the speech – titled "Designing Resilient Monetary Policy Frameworks for the Future" – would only address the Fed’s longer-term policy stance.
But when her words hit the wires, the US dollar first strengthened on hawkish-sounding headlines before weakening again as her comments were actually less pointed than the headlines suggested, and no major conclusions could be quickly drawn from the longer term policy discussion.
Later, however, the USD pulled sharply stronger again and ended the day and the week at its strongest level in almost two weeks. Much of the credit for the move was given to Fed vice-chair Stanley Fischer, who in an interview Friday indicated that Yellen’s remarks suggested as many as two rate hikes this year if the incoming US economic data are sufficiently strong.
But if the near-term rate hike talk is the only driver of the US dollar strength here, we can expect this strength to fizzle. The majority of Yellen’s speech, after all, echoed many recent comments from her colleagues recent output, and underlined that a number of factors have pushed the so-called “neutral rate” for Fed policy close to zero, indicating that the peak rate for the cycle may lay far lower than it has in the past.
So any Fed hawkishness is inevitably of the short-term variety as the bank sees little danger of an overheating economy or unpleasant jumps in inflation. The irony is that it is the Fed’s own policymaking that is contributing to the headwinds faced by economy growth, particularly low productivity.
Low and zero rates don’t allow bad debts to clear, and don't push unproductive actors into bankruptcy where they belong. It was also tiresome to note that that Yellen expressed the belief that forward guidance and QE – possibly with an expanded asset purchase mandate – remain the best tools to address future economic slowdowns.
This Jackson Hole speech was a great opportunity for the Fed to own up to its policy failures, and Yellen almost entirely failed to do so.
She also underplayed what is likely to be the most important driver of policy from here: fiscal stimulus.
If the market has begun buying US dollars and selling risky assets because of this short-term Fed hawkishness, look for the move to fade inside this week if the US data are weak and inside a month if not.
But perhaps the reaction to Yellen is something else entirely, and remains camouflaged by the pointless fixation on the rate hike calendar. The move higher in the US currency and lower in risky assets could instead be due to the exhaustion of the long-standing “reach for yield” trade that has driven markets since the meltdown seen earlier this year – the one that saw central bank activism from the European Central Bank, the Bank of Japan, and the Bank of England/Brexit taking German 10-year yields down to minus 7 basis points and driving desperate yield seekers into stocks and thus creating all-time highs for US stock indices.
If that is what is unfolding, we could be in for a long slide in asset markets and steep and sustained rise in the US dollar from here, especially against the riskiest emerging market and developed market currencies. In other words, the reaction could suggest that central banks are losing what little mojo they have left.
Are we approaching the end of the line for central bank policy activism? Photo: iStock
— Edited by Michael McKenna
John J Hardy is head of FX strategy at Saxo Bank