Breaking out the popcorn this Friday for Jackson Hole speech and then the Fed’s five-year policy review
Friday will see Fed Chair Powell’s Jackson Hole speech, which few expect will contain strong hints of the September FOMC decision due to the important incoming data awaited before that meeting, including the August jobs report, August CPI and August PPI (markets a bit more twitchy on that figure after the spike in the July data). Still, the tone could hint at the response function to that incoming data. It would have been more interesting for Powell to pontificate on Fed independence and point out the risks from continued fiscal profligacy, but perhaps those are points that Powell will save for his resignation/firing/end-of-term speech.

Also upcoming from the Powell Fed is the once-in-five-year policy review. The last review in 2020 saw the Fed announcing that it would be happy to allow a period of “catch-up” inflation to ensure that the average inflation over time achieved the 2% target. With the inflationary environment post-pandemic and more than enough catch-up inflation in the bag than the Fed ever envisioned, this idea will quickly end up in the dust-bin of history and should be scrapped in the review (it was already irrelevant). Also inevitably bound for the dustbin is whatever replaces it, as the exigencies of keeping the US treasury financed will only mount from here and will mean that the Fed will largely or entirely lose its independence, acting as an auxiliary to the Treasury’s needs, which could take some form of yield-curve-control, QE or even MMT-lite, and even capital controls or all three. Alas, that won’t be in this review either. I think the best, most commonsensical thing would be for the Fed to scrap the dot plot that was designed for an entirely different era in economic history and was only ever about reassuring the post-GFC market that the Fed had its back with forward guidance. Forward guidance from the Fed now offers mostly reputational risks with no rewards.

What are we waiting for as EURUSD can’t take out 1.1700 – and USDJPY can’t do anything?
There seems little conviction in this market as multiple attempts to reestablish the USD downtrend are failing, with extremely low volatility in risk assets and global bond markets likely to blame here. This suggests some risk that the side of least resistance is higher in the US dollar, but again, little conviction on that account when the price action is not providing any clues and we are still some way from the next catalysts outside of possible brief fuss over Jackson Hole. As discussed above and below, sovereign bond markets are spring loaded as the inevitable need to make new policy steps to relieve pressure on government finances have explosive potential implications for currencies as a safety valve when yields won’t be allowed to absorb market forces. On that note, long yields are pressurizing the situation in Germany and the UK, where the long 30-year gilt is threatening to hit multi-year highs today after a surge yesterday.

Chart: USDJPY
Yields are pressuring slightly higher here, if insufficiently so to support a fresh rally in USDJPY. The MOVE index of US yield volatility, in fact, has declined to a post-late-2021 low. If we recall, the November 2021 time frame saw Powell-Brainard acceptance speeches for nomination as Fed Chair and Vice Chair pointed to the coming Fed war on inflation.  This sparked a long period of higher interest rate volatility. Ironically, this interest rate volatility is now on the decline when the longer term questions about the long-term pressures on sovereign bond markets in the US, Japan, UK and elsewhere are more burning than ever. Longer term, direction for USDJPY will be driven by the policy options taken by both Japan’s Ministry of Finance/BoJ and the US Fed/US Treasury. Technically, the 12 days of going nowhere after the monumental reversal from the squeeze above 150.00 has weakened, if not yet eliminated, the implications of that reversal. We need to take out perhaps 146.00 or 149.00 on a daily close together with a policy move or expanding volatility from global bond markets to get a sense that we establishing a new trend.