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Dovish Powell ends the FX summer lull
After a recent string of Federal Reserve officials arguing the case for slowing the central bank’s quantitative easing (QE) program, Fed Chair Jerome Powell took a different line in his speech at the Jackson Hole symposium last week. Our Head of FX and Interest Rates Trading, Demitri Theodosiou, examines what it means for markets.
The summer holidays are well and truly coming to an end. A sigh from many children across the country that playtime is over, a skip in the step of many parents who are likely lining up a glass of Prosecco to greet them when they get back through the door after the first drop-off of the school year. The same giddy sentiment is permeating through the Investec team this week, captured perfectly by our sales lead, Ria Selvaratnam, excitedly exclaiming, “Everyone’s back!”
Client emails are flying in, people are arranging office returns, and FX markets are picking up after the usual summer lull. In financial markets, the big summer event in the calendar is the Federal Reserve Chair speaking at the Jackson Hole Economic Symposium. In recent years, the event has been used to signpost upcoming US monetary policy and usually transitions us from sleepy summer markets back into full throttle moves; this year was no different.
Leading up to Jerome Powell’s Jackson Hole speech, we saw a stronger US dollar. This was partly on expectations that the Fed would lay out plans to shortly begin tapering their QE program (fueled by a string of hawkish Fed speakers in the days prior). It was also partly on safe-haven flows as concerns grew about a global economic slowdown amid the spread of the Covid-19 Delta variant in China and the US. What we got from Mr Powell, though, was a more dovish tone.
The Fed may taper, but don’t expect that to mean that interest rate hikes will automatically follow very soon. US labour market reports will become central for policy and market expectations in the coming months.
While he gave an implicit nod that the Fed will likely taper QE soon as progress on inflation and employment goals had been made, his most significant and surprising comment was that “a different and substantially more stringent test” would need to be met for rate hikes. In this regard, he said there was “much ground to cover to reach maximum employment” and “time will tell whether we have reached 2% inflation on a sustainable basis”.
He also stressed that “the timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate lift-off”. He again emphasised the likely transitory nature of the current burst of inflation and cited that underlying wage growth was still moderate. He further added that there was little reason to believe the slow-moving global disinflationary forces over the past quarter of a century had suddenly disappeared, let alone reversed.
Since then, the greenback has weakened across the board, allowing the pound some respite after a difficult month, and stock markets are looking a little healthier, safe in the knowledge that the Fed Chair carries a more dovish stance than was expected. Even weaker Chinese PMIs to start the week were shrugged off by the local markets, perhaps anticipating the Chinese central bank would follow the Fed’s continued stimulus path.
The Fed may taper, but don’t expect that to mean that interest rate hikes will automatically follow very soon. With it being clear that major central banks worldwide continue to see elevated inflation as transitory due to last year’s Covid-19 effects, for me, the big takeaway was the focus on the employment goal as the key indicator to any Fed policy shift. US labour market reports will become central for policy and market expectations in the coming months. US non-farm payroll and wage data are released this Friday, and with them, I think it’s safe to say summer markets are over and “we’re back!”