Currency markets jumped at the end of last week, given commentary from major central bank officials at the Fed’s annual symposium in Jackson Hole, Wyoming. But, having a couple of days to digest what actually was announced, the markets could pare back some of those moves. The initial knee-jerk reaction could have had more to do with pent-up anticipation than a major shift in outlook.
The heads of the BOE, BOJ and ECB all spoke at the meeting. But what got most of the headlines was Fed Jair Jerome Powell’s speech. There had been growing trepidation that he would stick to the “wait-and-see” mantra, and echo the hawkish tone of the FOMC minutes. However, he delivered on the dovish expectations, opening the door for a rate cut in September. The dovish headline takeaway was offset by some other details that he mentioned, which could gain more weight as markets assess the longer-term policy outlook.
Not So Sure About A Cut
The dollar weakened in the aftermath of Powell’s speech, as the market raised the odds of a rate cut in September. The futures market priced in just under a 90% chance, which was up from a little bit less than 70% chance immediately before the speech. However, that’s where the chances were just a week earlier, after the CPI data came out. It means markets are still not totally sure that the Fed will actually cut in September.
Additionally, the chances of a second rate cut rose by just 4 basis points, which is practically unchanged. Those chances have already started to diminish at the start of the week. In other words, the large move in the dollar might have been excessive, and this week could see a return to the prior levels.
A Hawkish Policy Change
The other thing that Powell mentioned was his commitment to the long-term 2% rate target. This is significant because back in 2022, as the post-pandemic inflation was starting to lift off, the Fed modified its inflation policy by suggesting that an increase to 3% would be tolerable. The idea was that inflation had been below target for a while, so if it went above target for a bit, that would compensate to keep the long-term rate around target.
Since then, inflation went well above target, erasing the effect of the lower inflation rate in the 2010s. Which means the Fed will no longer “tolerate” inflation rates rising to 3.0%. This is actually a more hawkish position than what the Fed had up until this point. Given the current inflation rate of 2.7%, the FOMC could be more willing to keep rates elevated to bring down inflation.
BOJ and ECB Commentary
The USDJPY also moved sharply, not just because of the weakness in the dollar. BOJ Governor Kazuo Ueda spoke on Saturday, giving his usual hawkish stance an added twist. He talked about how he expected wages to accelerate as salary increases among large firms spread to smaller companies. As a result, markets moved to price in a 50-50 chance of a BOJ rate hike in October. This is sooner than previously expected, which was a potential hike by the end of the year.
ECB President Christine Lagarde also spoke, but her intervention was notable for not addressing monetary policy issues, leaving the Euro largely untouched. The Eurozone’s inflation is practically on target with a sluggish economy, meaning that policy could remain unchanged for quite some time.
