FX Watch: Powell's speech leaves markets unclear, Yen nearing intervention threshold

Jackson Hole: Powell Sticks to Script, Dollar Closes Six Weeks of Gains

At the annual Jackson Hole Economic Policy Symposium, US Fed Chair Jerome Powell was seen to be leaning slightly hawkish, warning of additional rate hikes as inflation remains too high. There was also a more firm language around the 2% inflation target, putting speculations that Fed may consider raising the inflation target to rest. However, comments were balanced as he acknowledged the moderation in price pressure and said the Fed would proceed carefully on whether to tighten further.

US economic data has continued to surprise to the uprise for now, which Powell thought could put further progress on inflation at risk and warrant further tightening. Given the longer -term focus of the conference, it was a surprise that Powell stuck to a data-dependent approach and did not show any concern for the deteriorating outlook of the US banking sector. The event was a reminder of the complexity of the end-of-cycle dynamics, where cyclical disinflation trends are noteworthy but inflation faces structural upside risks from green transformation and a fragmenting world.

These hawkish-leaning comments from Chair Powell saw market push the rate cut expectations to June 2024 from a month earlier previously. However, the market is still reluctant to price in any further rate hikes at this point, and a data-dependent approach will likely be maintained. This week’s July PCE may continue to signal the cyclical disinflation, but focus would be largely on nonfarm payrolls and ISM manufacturing due on Friday to assess whether there are any risks of an inflation upside in the near-term.

The speech was overall positive for the dollar, as it left some scope for further tightening that is currently not priced in by the markets. If data supports and markets price in another Fed rate hike, the USD could push higher. Even if the data continues to weaken modestly, as is evident currently, Powell has reaffirmed that the Fed is not in a hurry to cut rates. More urgency to cut rates is still seen in Europe, UK or China, which still enables a favourable environment for now, unless US economic data deteriorates materially to push forward interest rate cut projections forward. In that case as well, a safety bid for the dollar cannot be ruled out.

US dollar saw choppy price action as Powell spoke at the symposium, but the high-for-longer message drove short-term Treasury yields higher with the 2-year closing at 5.08%, its third consecutive weekly gain, and seeing some further upside in the Asian session today. DXY index is threatening critical resistance at 104.30 and may however be prone to some consolidation/retracement after six consecutive weeks of gains. Near-term support at 103.50 ahead of the 200DMA at 103.12.

Market Takeaway: Dollar index up-trend still intact – some consolidation risk to 103-103.50 ahead of Friday jobs report.

ECB’s Lagarde Stays Away from Near-Term Policy Direction

While structural influences on inflation and a “new playbook” were essential parts of the ECB President Lagarde’s speech at Jackson Hole, there were still little signals on what comes next at the September meeting for the central bank. Lagarde highlighted the importance of establishing interest rates at a sufficiently restrictive level for a prolonged period to ensure the prompt attainment of the 2% medium-term inflation objective. Still, there was no confirmation about another rate hike, and markets remain reluctant to price in a September rate hike after dismal Eurozone PMI readings earlier. German Ifo business climate also suggested further weakening on Friday, falling for the fourth month in a row and adding to fears that the economy may be heading for its second recession in the year.

CPI reading for the Eurozone is due out on Thursday and a firm core print could bring some increase in pricing of a rate hike in September, even as core inflation is expected to cool from next month. Next month’s CPI data will however not be available in time for the ECB’s meeting on 14 September, and Lagarde’s comments suggested that she doesn’t trust inflation models based on old data given we are in this new regime of higher structural inflation. This could mean that August inflation print this week will be a make-or-break matter for ECB expectations, before economic risks elevate further. EURUSD pushed to fresh over 2-month lows of 1.0766 before recovering to 1.08 handle in the Asian session. Support at 1.0750 and upside could bring support-turned-resistance at 1.0835 in focus.

Market Takeaway: Correction risk in EURUSD up to 1.0835 with eyes on Eurozone August CPI.

JPY Still Vulnerable to Downside Pressure

The combination of a hawkish-leaning Powell and a dovish Ueda was catastrophic for the Japanese yen. Bank of Japan governor Ueda spoke at the Jackson Hole conference on Saturday and talked about the structural shifts in the global economy, saying that geopolitical tensions and tendencies towards “reshoring” — the return of manufacturing activities and jobs to home countries could be an inflection point. He said that while that could lead to local growth booms, it could also result in production inefficiencies. However, Ueda maintained that he viewed Japan’s underlying inflation to be still below the 2% target and that is reason why they will stick with current easing framework.

USDJPY rose to fresh 9-month highs of 146.63 amid yield divergence being in play again. Some reports have also noted that algorithmic trading continue to be pinned on US yields alone, and do not take the rise of Japanese yields into account. If US data, and consequently US yields, continue to be firm, we could see increasing pressure on JPY. Meanwhile, intervention threat has retreated at sub-150 levels, given lack of any FX comments from Ueda at the Jackson Hole conference and no signs of verbal intervention yet.

Market Takeaway: Minimal intervention risks keep USDJPY on track for more gains, but caution to prevail as pair punching at fresh cycle highs.

China Measures Fall Short of Keeping Markets Excited, AUD Rallies on Retail Sales

The Chinese yuan was modestly up last week after PBoC’s steady fixings suggesting a greater hand in the currency movements. Chinese sentiment took a modest positive turn at the Asian open today after the authorities announced four significant measures to provide support to the equity market on Sunday. Our morning Quick Take discussed these measures that ranged from stamp duty reduction to tightening IPOs and more. USDCNH moved to lows of 7.27 before returning to 7.29 as investors remains cautious of a turnaround in Chinese economy. PMIs due this week may signal further concerns, and expectations of more Chinese stimulus measures in a divergence to tighter global monetary policies suggests pressure on yuan could stay despite the authorities’ signals to keep the depreciation paced.

AUD, the G10 underperformer on a QTD basis, stands a greater chance to benefit from Chinese stimulus measures although dollar strength is a headwind. Australia’s July retail sales also surprised to the upside, coming in at 0.5% MoM, but was potentially bumped higher due to the additional spending linked to 2023 FIFA Women’s World Cup and school holidays. AUDUSD rose to Friday’s high of 0.6440 in the Asian morning again today, and break will bring focus on 0.65 and 38.2% retracement level of 0.6569. July inflation due to be released on Wednesday, and a preview is included in this week’s Saxo Spotlight, but bigger focus likely on China PMIs that are also released this week.

Market Takeaway: Scope for recovery in AUDUSD may be limited if China PMIs fail to show a strong recovery.