Morning Brief – Mocking Jay

Mocking Jay

Federal Reserve President Jay Powell will speak today at the virtual Jackson Hole Symposium. The event has already taken its toll on global markets and the US Dollar in particular with cautious words from Kansas City and Richmond Fed presidents weighing heavy on the greenback. The last Federal Reserve meeting that the market got the opportunity to have an in-depth look at was July’s. What we learned was that the Fed wasn’t quite as committed to its expansionary warpath as previously thought. Against this backdrop here’s what to expect from today’s speech.

Jackson Hole is an overpriced skiing town for most of the year. However, for one week only it becomes the host town of the world’s elite business executives, central bankers and politicians with a private security bill that even Harry and Megan would scorn at. This year it will be held in a virtual capacity but already it is proving that it can still pack its usual punch when it comes to market moving headlines. Yesterday Kansas City Fed President Esther George introduced the wider market to the propensity for a ‘double-dip’ recession should the virus spread once again. Richmond’s Fed President Thomas Barkin also left the Dollar facing a headwind following his speech warning once again of the prevalence of unemployment within the US economy. Despite the speeches made yesterday the US Dollar held relatively firm with markets awaiting Chairman Powell’s speech today.

Market recently learned that American central bankers were not in fact as open to the kind of hyper accommodative monetary policy that the market had expected them to produce. In particular, markets saw that in July members of the Federal Reserve were not as in-tune with their yield-destroying (and therefore Dollar-toppling) policy of ‘explicit yield curve control’ as previously believed. The correction in US yields which in turn encouraged a stronger US Dollar following July’s minutes was neither severe nor negligible. Given that the Chairman is certain to be of the belief that the US economy faces chronic risks, not least because of his chum vying for another four years in the White House, he is likely to offer a somewhat cautious and perhaps even dovish tone note during his speech later today.

It looks like yield curve control and more aggressive market manipulation is out of the question following the July minutes. Given that markets are still following the Federal Reserve closely and believing in the support that it has offered, Powell is likely to maintain the tone the July minutes unveiled. However, the Chairman will have the possibility to discuss alternative policy measures that would de facto imply lower yields and accommodative monetary policy for the longer term. A move to pursue such policies would be interpreted as dovish by the market and lead to a flow of money away from the US Dollar.

One such policy would include the setting of a higher inflation target than the US Fed currently aims for. Higher rates of inflation demand a cheaper cost of money (interest) in order to stimulate the economy to encourage higher prices. At the moment a 0.25% interest rate is struggling to get close to the Fed’s inflation target of 2%. If the Reserve was to hike up it’s target of inflation then already accommodative policy at 0.25% would prove to be even more insufficient and push the market further into its belief that more Dollar-sacrificing monetary support is to come. Not only that but a higher target inflation rate will de facto imply that policy remains looser for longer. Consider inflation rises to the Fed’s current 2% target. If the Reserve Bank has already moved the target to 3% then a policy response would be demanded at a later stage to keep the rate in line with target. If such an initiative is unveiled by Powell today expect the Dollar to sell off. If no such suggestion or economic caution comes from the central banker then expect the Dollar’s recent consolidation to continue and even accelerate.

Discussion and Analysis by Charles Porter

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