USD drops further as Powell confirms policy focus shift

USD: Powell’s speech had a more powerful FX impact than we expected

Prior to last Friday’s speech from Fed Chair Powell, the dollar last week had already taken another leg lower – by about 1.5% - on the drip feed of rhetoric from Fed officials indicating that the FOMC was ready to commence cutting rates at the following meeting in September. Fed Presidents Bostic, Kashkari, Daly, Collins and Harker had all indicated this view so we felt the most likely outcome of the speech was for Powell to endorse these sentiments. And while this is what happened of course as always market reactions can be about nuances and finer details. Two come to mind. Firstly, Powell was a bit more explicit and forceful in expressing the view of a rate cut taking place in September. Often central bankers tend to hedge their bets with degrees of ambiguity but not at all this time. Secondly, there was considerable emphasis on the labour market suggesting even greater concerns over downside labour market risks. The comment from Powell that the Fed doesn’t “seek or welcome” further labour market cooling and that the Fed would do “everything we can” to support the jobs market gave the impression to the market that the Fed could be more concerned over the jobs market than previously assumed and that because of that there remains scope for the FOMC to cut by 50bps at the meeting on 18^th September. We had assumed that Powell in this speech would indicate confidence that the Fed was not behind the curve and that steady 25bp cuts was all that was required. That message was not really portrayed. In the section of the speech covering the policy outlook Powell stated that the “timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks”. The very next sentence was when he stated that the Fed would “do everything we can to support the labour market” clearly suggesting bigger cuts were plausible if required, especially now given the labour market is deemed as no longer being a source of upside inflation risks. Powell added that there was “ample room” to respond to labour market weakness.

So the reality of this speech was to highlight the scope the Fed has if the data was to indicate that the Fed was behind the curve and this was the catalyst for the drop in front-end yields and the larger dollar sell-off.

In the 16-day period (since 1^st August), the dollar plunged by nearly 3.5% - that’s the biggest drop in that period since Q4 2022 when the dollar plunged from its global inflation shock highs way higher at levels between 112-114. The drop this time is from lower levels taking the dollar through the December 2023 lows toward the lows in July 2023. A breach of the July 2023 low (99.578) will be a test over the coming two weeks ahead of the jobs data on 6^th September. Weak jobs data then would likely see lower levels and a key technical break taking us to levels not seen since the early phase of the global inflation shock in Q1-early Q2 2022. The NFP report on 6^th September is now hugely significant.

16-DAY % CHANGE (1^ST AUG TO LAST FRIDAY) – BIGGEST DROP IN DXY SINCE Q4 2022

Source: Macrobond & Bloomberg

GBP: Bailey conveys a more cautious approach

BoE Governor Bailey was also at Jackson Hole last week and there was certainly a more cautious tone to the speech from Bailey in contrast to Fed Chair Powell’s speech. But that is of course understandable. There was a far larger energy price shock in Europe than in the US and the problem in Europe was more supply less demand related whereas in the US, demand was a bigger influence which has allowed the Fed to be communicate a clearer message on rate cuts given the signs of weakening labour market demand. Of course in Europe, the BoE and the ECB have already cut rates and therefore there is perhaps less urgency.

Governor Bailey’s statement that it is “too early to declare victory” over inflation adding that inflation was not yet back at target on a sustained basis and that policy will need to remain “restrictive for sufficiently long” highlighted those concerns. But there was important additional comments underlining the progress being made continues. Bailey crucially stated that second round inflation effects “appear to be smaller than expected” and that the BoE had seen a “revision down in our assessment of that intrinsic persistence” of inflation.

The comments had no big impact on market expectations and the BoE remains on course to cut again at the November meeting. Just 6bps of cuts are priced for the September meeting. Given the 5-4 vote a September cut we see a September cut as very unlikely. Still, there was further good news today in the data with the BRC revealing deflation has returned to the high street with a 0.3% drop in shop prices in August from a year earlier, the first drop in nearly three years as retailers introduce discounts to shift inventory after weak summer demand.

The pound continues to lag in G10 this month – the second worst performer – but remains the top performing currency this year. The faster drop in inflation coupled with the expected caution from the BoE (suggested again by Bailey in Jackson Hole) leaves the BoE with the expected most attractive real policy rate across G10 by the middle of next year and this fact will continue to act as a support for the pound. We will be adjusting higher our GBP forecast profile in the next forecast update to be published on 2^nd September in the Foreign Exchange outlook.

GBP LONG POSITIONS AMONGST LEVERAGED FUNDS BEING REDUCED AS GBP HITS HIGHEST LEVEL SINCE MARCH 2022

Source: Macrobond & Bloomberg

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
UK	11:00	CBI Distributive Trades Survey	Aug	-11	-43	!!
CA	13:30	Wholesale Sales (MoM)	Jul	--	-0.6%	!
US	13:55	Redbook (YoY)	--	--	4.9%	!
US	14:00	House Price Index (YoY)	Jun	--	5.7%	!
US	14:00	House Price Index (MoM)	Jun	0.1%	0.0%	!
US	14:00	House Price Index	Jun	--	424.6	!
US	14:00	S&P/CS HPI Composite - 20 s.a. (MoM)	Jun	--	0.3%	!
US	14:00	S&P/CS HPI Composite - 20 n.s.a. (MoM)	Jun	--	1.0%	!!
US	14:00	S&P/CS HPI Composite - 20 n.s.a. (YoY)	Jun	6.2%	6.8%	!!
EC	15:00	ECB's Nagle speaks				!!
US	15:00	CB Consumer Confidence	Aug	100.9	100.3	!!!
US	15:00	Richmond Manufacturing Index	Aug	-14	-17	!
US	15:00	Richmond Manufacturing Shipments	Aug	--	-21	!
US	15:00	Richmond Services Index	Aug	--	5	!
US	18:00	M2 Money Supply (MoM)	Jul	--	21.03T	!

Source: Bloomberg