Having got off to a poor start to the week, US markets finished yesterday with a decent rebound ahead of today’s speech by Fed chairman Jay Powell, which is scheduled for 3pm UK time.
European markets have also stabilised in the past couple of days after some early week declines and are expected to open modestly higher this morning.
Sometimes it pays for central bankers to be deliberately ambiguous when it comes to talking about monetary policy, in that it allows the flexibility to argue they’ve been misunderstood.
Previous Fed chairmen have employed this to good effect with Alan Greenspan once famously being quoted as saying “I know you think you understand what you thought I said, but I’m not sure if you realise that what you heard is not what I meant”.
Is this what Powell was doing when he said that the Fed funds rate was is in the range of what they think is neutral, at between 2.25% and 2.5%, a remark that he was widely lambasted for.
Since then, a series of Fed policymakers have pushed back hard on that narrative, however that hasn’t stopped the markets from taking the view that the Fed could well start cutting rates sometime next year.
This appears to be predicated on the somewhat naïve belief that inflationary pressures may well diminish sharply given the recent decline in headline CPI to 8.5%. The reality is that the Fed will want to be sure that inflation is falling at a sustainable enough pace before it signals any sort of dovish shift or pivot, especially if inflation turns out to be stickier than expected.
If inflation finds a base at a level which is still well above their 2% target its extremely unlikely the Fed will lean into any sort of guidance that suggests a rate cut is coming, especially given that their median view on core PCE is to be back at 2.3% in 2024. This would suggest that rates are likely to stay higher for longer, and that “neutral” far from being at 2.5% is quite a bit higher, and much nearer to 4%.
We already know that further rate rises are likely between now and year end, and with only 3 meetings left between now and 2023, and a consensus on a Fed funds rate of between 3.5% to 4%, we can probably expect to see at least one more 75bps rate hike, which is likely to come in September.
In the past few days, we’ve heard from the likes of St. Louis Fed President James Bullard, and Neel Kashkari of the Minneapolis Fed, who are targeting a Fed funds rate of 3.75% to 4% by year end, and while Kashkari isn’t a voter this year, historically he’s been one of the more dovish Fed members.
This puts Powell in the rather tricky position of having to let markets down gently, and while he isn’t likely to give a definite steer on whether we get 75bps or 50bps next month, the latest jobless claims data would suggest the Fed has ample room to keep its foot in when it comes to another 75bps move.
He therefore needs to put to bed any idea that somehow rates will start to come down much before 2024, and in so doing, in contrast to last year when the narrative was lower for longer, he’ll need to craft the message of higher for longer, without prompting a meltdown in bond markets.
Before Powell is due to speak, the latest PCE core deflator data for July is expected to reinforce the weaker inflation narrative, having seen core PCE jump to a record high of 6.8%. This jump higher raises the prospect that inflation is starting to become much more embedded into the US economy and will be something the Fed won’t want to see.
Given the current tone amongst Fed policymakers the bias is more likely to lean towards a tendency to overtighten in the short term, and ease off towards year end, than the other way around, especially since personal income and spending data appears to be holding up well. These are both expected to show a rise of 0.6% and 0.4% respectively in July.
EUR/USD – has managed to hold above the 0.9900 level this week but the bias remains for a move towards the 0.9620 area, while below 1.0220. We also have major trend line resistance from the January highs at 1.0280.
GBP/USD – held above the lows this week at 1.1718 area but rebounds currently remain weak. Bias remains to the downside towards the lockdown lows of March 2020 at 1.1500. Resistance comes in at 1.1980 area.
EUR/GBP – continues to find support above the 0.8410 area where we have trend line support from the recent lows. We also have resistance at the 0.8510 area, and the 50-day MA.
USD/JPY – continues to hold above cloud support at the 136.10 area but needs to overcome the highs this week at the 137.70 level, to open the 139.40 area and previous peaks. Major support comes in at the 50-day SMA at 135.70.
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