Jackson Hole and the Dollar

Powell yesterday opened the door to a September cut, which is now a done deal

Yesterday’s Jackson Hole speech by Chair Powell was dovish. This wasn’t so much true for its characterization of the labor market, where it noted that job growth has slowed, but that this does not appear to have opened up a large margin of slack due to slower immigration. Instead, the speech was very dovish on inflation, where it mostly dismissed the risk of second-round effects from tariff price hikes into persistent and broad-based inflation. The speech concluded that “with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance.” This language signals that a September rate cut is essentially a done deal.

Markets pricing immediately moved in a dovish direction following the speech. Cuts priced through the end of next year went from 124 basis points before the speech to 136 basis points after (top left), a very substantial dovish repricing. The 2y2y forward rate differential of the US vis-à-vis the rest of the G10 moved very sharply against the Dollar (top right), reaching a new low in its ongoing decline since inauguration.

So what about the Dollar? The Dollar has been on a rising trend since its low on July 2 (bottom left). It gets hit periodically by Dollar-negative news, like downward revisions to payrolls on August 1 or CPI data on August 12 that showed a slowdown in tariff-led inflation. Each time the Dollar dusts itself off and resumes its rise. I expect this time to be no different, especially as yesterday’s fall in the Dollar was inordinately large relative to the move in the 2y2y forward differential (bottom right). Currency markets “overtraded” Powell’s Jackson Hole speech. I expect the trend rise in the Dollar to resume once markets realize this.

What to make of Fed cuts? In 2019 - after withering criticism of Powell by Trump - the Fed did its “mid-cycle adjustment,” a 75 basis point easing cycle. Powell is an astute tactician who knows how to handle difficult situations. Had he not cut in 2019, who knows how bad the confrontation with Trump might have become. It’s similar now. Better to cut a little bit and take the edge off. That said - from the perspective of the Dollar - I can’t see how any of this is particularly negative, since markets price so many cuts at this point. Taking the edge off means a cut in September. It’s far from certain what happens after that. As a result, the balance of risks for the Dollar is to the upside.