Dollar gains after hawkish Warsh speech
Friday was very much dominated by Fed Chair Warsh’s much anticipated speech in Jackson Hole. That conference had often been used by previous Fed chairs for major policy speeches but there was a risk Warsh would say very little given his predisposition to less rather than more communication about monetary policy. In the event he did not disappoint, however, and his speech struck a hawkish tone, saying the underlying trends in inflation have not ‘meaningfully improved’ and that the Fed might have ‘work to do’. That sent the dollar higher, with the euro falling from about $1.1650 to around $1.1580, while sterling dipped from close to $1.36 to $1.3530. The euro lost a little ground to sterling, and is now trading around 86.6p. US yields also moved higher as the chances of a near-term Fed rate hike increased, particularly at the short end of the curve.
Warsh’s speech on Friday laid out that he thought that the US economy was in a strong position but inflation had not materially weakened enough. He re-affirmed the Fed’s commitment to a 2% PCE target as a ‘firm fixed target’, thus emphasising the Fed’s commitment to price stability. He said the US economy ‘appears to have strengthened’ and pointed to consumption and investment combined increasing at a rate of nearly 3%, which he said is carrying more ‘signal’ about the economy than headline GDP. Credit markets are ‘showing few signs of restraint’ and where some sectors (agriculture and housing) are showing strains he would be ‘hard pressed’ to describe ‘broad financial conditions as restrictive’. Regarding the labour market, he said he believed the situation was ‘consistent with full employment’.
With the Fed chair laying out that he thought the economy was in good shape and financial conditions were ‘not restrictive’, the key was his views on the inflation environment. He said that ‘progress (on inflation) over the past two years has been modest’ and the numbers were ‘concerning’. He added that ‘PCE and CPI readings were better than expected (but) they do not tell me that underlying trends have meaningfully improved’ and that his standard was that they must be confident that underlying inflation is moving to the (Fed’s price) objective at a ‘clearly sufficient speed’, otherwise the Fed may ‘have work to do’. This sent a clear signal to the market that interest rate hikes are under consideration. Two weeks ago, there was a 55% chance of a 25bps rate hike at October’s FOMC meeting with just one and a half hikes fully priced in by the end of next year. Today, markets are pricing in a 90% chance of an October hike and nearly two and a half hikes priced in by the end of next year.
Unsurprisingly, US yields moved higher. Two-year yields were up 11bps to 4.35% while 10-year yields were up 4bps to 4.72%. Euro area yields were also up, with two-year German yields up 4bps to 2.9% and 10-year yields up 3bps to 3.28%. UK yields too increased, with 10-year yields up 3bps to 5.06%. US equities suffered on Friday, led down by tech stocks, with the S&P losing a quarter point on the day and the Nasdaq losing a half point. Better news for European equities, which outperformed, with the Eurostoxx up nearly 1% for the day and on track for a fifth consecutive monthly gain, and the FTSE up 0.3%.
While the news from Jackson Hole was dominated by Warsh, there were several other notable central bank speakers. ECB member Kocher said that Europe’s economy is ‘more resilient than many think and is gaining momentum’, while adding that there is ‘no complacency’ on inflation. His colleague Dolenc said that growth in Europe was ‘exceeding expectations’, adding there were arguments for a September rate hike. The EU economic confidence data for August was also positive, increasing to 98.4 from 97.1, with both services and industry indices improving. Finally, BoE Governor Bailey played down the chance of a near-term rate hike from the MPC, saying second-round inflation effects are ‘quite subdued so far’ and that he has taken the view that the BoE can ‘watch this situation for the moment’.
For the week ahead, we get the ‘flash’ inflation estimate for the euro area, with the consensus forecast at 3.3%, the fastest since May 2023. Also due are euro area unemployment and retail sales. In the US, we get ISM readings and the Fed Beige Book, but the key event will be Friday’s non-farm payrolls for August, with a modest 55k increase as the consensus forecast following an unexpected -23k reading in July. Speakers this week include ECB’s Lane and Nagel, BoE Governor Bailey, and Waller and Barr from the Fed. There will be other central bankers speaking too this week before the ‘quiet’ periods for the ECB and Fed kick in ahead of their respective meetings later in September.