Kevin Warsh will formally come Chair of the Federal Reserve on Monday in a complicated and somewhat unprecedented situation. For markets, the question is whether rates will go up or down, and new leadership always clouds that question. The the pressure that the Fed has been under lately, plus the controversies surrounding Warsh’s appointment make the outlook even more uncertain.
Forex traders already have enough to think about when it comes to the direction of the dollar, gold, crude prices and even commodities, all of which could be affected by Fed policy. Over the last week, the dollar has gotten stronger despite a supposed dove taking over at the FOMC. The more immediate question for traders is whether that trend will continue.
Doves Become Hawks
US President Donald Trump has put a lot of pressure on the Fed to lower rates despite high inflation. He even has the opportunity to appoint Stephen Miran to the board last year, who became an constant dissenter, voting for lower rates. But, uppont Warsh’s appointment Miran announced his resignation, while former Fed Chair Jerome Powell will stay on as Governor. This is a fairly unusual move, as typically the former Fed Chair will also resign as a member of the FOMC.
This leaves the Board with one less dove and a apparently committed hawk. Presumably, Trump will appoint more doves to the Board to bolster Warsh. However, despite being hand-picked by the President, Warsh has not been explicitly dovish. In fact, since being nominated, he’s been fairly quiet on his monetary policy views, and actually stuck to Powell’s position on Fed independence. Now that he actually has the job and is facing the economic data, will he remain dovish? After all, Powell was also hand-picked by Trump years ago.
What Are the Odds for a Fed Action Now?
Markets are now pricing in a more than 40% chance that the Fed will hike by the end of the year. That up from 20% since before Warsh’s appointment, though attributable to hotter than expected CPI and PPI data this week. More importantly, the market has priced out any rate cuts for the foreseeable future, essentially betting that the easing cycle is over.
As a result, the dollar was among the top performing of major currencies last week, losing ground only against the Yuan. Only (supposed) intervention by the BOJ on Tuesday to shore up the yen kept the dollar weaker against that currency. Unlike other countries where talk of higher rates weakens the currency amid fears the economy will slow down, the dollar has gained on higher yields.
Will the Dollar Continue to Rise?
The greenback has also gained after positive developments in the Trump-Xi meeting this week. That’s because the strength in the currency is reliant on expectations that the economy has bottomed out and will surge forward. While this is overall positive for the currency, it means the Fed will be in no position to ease. In fact, it might actually have to raise rates.
Traders will be closely watching Kevin Warsh’s first public speech as Fed Chair to see whether his dovish reputation persists now that he’s in charge of the central bank. With scant US economic data in the coming week, Fedspeak could be the driver for the dollar and gold.
