Dollar erases gains on September hike doubts, yen extends rally
The dollar retreated on Thursday as investors grew doubtful the Fed would follow through with a rate hike at its September meeting.
Highlights:
- US dollar reverses gains as markets question September Fed hike.
- FOMC member Waller lauds US inflation progress, favours a hold.
- NFP report set to show a solid rebound in job creation in August.
- Euro rises above as markets eye ECB rate hike.
- BoE rate-setter Pill hints at insurance rate hike.
- Gilt markets calm after aggressive sell off.
The greenback has now given back more than half of its gains since Fed Chair Warsh’s hawkish set of communications at the Jackson Hole symposium last Friday. This follows relatively dovish remarks from fellow voting member Waller on Thursday, who not only welcomed recent progress on US inflation but explicitly signalled he was likely to vote for a hold at this month’s meeting. While this is far from a guarantee that other officials will follow suit, the fact that Waller is as centrist and data dependent as they come lends his comments added weight. Warsh’s own remarks, meanwhile, are probably best taken with a pinch of salt given his well-documented aversion to explicit forward guidance – suggesting September hike bets may be overdone.
Bond markets have continued to calm in the past day or so, which has probably added extra support to the dollar retracement as investors unwind a few safe haven flows. The sharp rally in the yen also likely contributed to the broader dollar sell-off. The USD/JPY pair now appears primed to test the key 155 level after a solid 30-year JGB auction, intervention speculation and – more pertinently – rising bets in favour of a September hike from the Bank of Japan. While we think that calls for a 50-basis point rate increase are rather laughable given the bank’s preference for caution, we do think that a standard 25bp move is highly likely at this stage.
USD
The recent whipsawing in Fed rate expectations continued on Thursday following some surprisingly dovish remarks from FOMC official Christopher Waller. Waller both said that he saw signs that US inflation was coming back under control and that he was inclined to vote for a hold if data continued to improve in the coming weeks. These remarks are fairly meaningful as not only is Waller an active voting member on the committee this year, but he is generally seen as a centrist rather than an outright dove, so his views seem to be a fairly good representation of the wider group. Futures markets now see a hike at the Fed’s September meeting as a coin toss. While we continue to favour a hold, clearly next week’s inflation report for August will be highly important.
In the meantime, focus today shifts decisively to the monthly nonfarm payrolls print (13:30 BST this afternoon). Economists expect a solid rebound in net job creation following July’s surprise contraction to levels consistent with a lukewarm labour market that – giving the historically low breakeven employment level – is neither firing on all cylinders, nor showing signs of complete capitulation. With a hike at the September meeting now a very open question, expect an unusually high degree of volatility in markets surrounding both today’s payrolls report and next Friday’s inflation data.
EUR
Receding bets in support of a September Fed hike helped boost the euro back above on the dollar yesterday. Activity in the EUR/USD pair continues to be largely a broader dollar story. Euro Area economic news has not exactly been of zero importance, but with a 25 basis point rate hike from the ECB effectively locked in for next week, there is very little room for the data to move the needle materially. Retail sales figures for July will be out this morning, with ECB chief economist Lane to speak as well, but we don’t expect either to be particularly market moving.
All eyes will instead turn to next week’s Governing Council rate decision. As mentioned, we think that a 25bp hike is effectively nailed on with headline inflation rising above 3% and the war in Iran continuing to drag on without a clear ending in sight. We are not, however, expecting Lagarde to sound an overly hawkish note that would tee up further hikes beyond this month. The ECB itself as said that any rate increases beyond 2.5% in the deposit rate would take policy into restrictive territory – a move too far, in our view, given the growth risks and the fact that the inflation problem remains almost entirely due to supply-side issues.
GBP
Sterling found a bit of a bid on Thursday, with hawkish remarks from Bank of England chief economist Huw Pill helping to temporarily override concerns over the rout in Britain’s gilt market. Pill suggested that raising UK rates now in response to the energy crisis would reduce the need for more aggressive hikes down the road. We remain far from convinced that a hike is actually coming, however, and are not reading too much into his commentary. Pill has shown himself to be one of the most hawkish members on the MPC, so his remarks are unlikely to represent the committee’s majority view. Even taken at face value, this rhetoric is also consistent with, at most, a one-off insurance hike – not the start of a full-blown tightening cycle.
Gilt yields have retreated over the past 24 hours or so – the 30-year yield has pulled back from near three-decade highs – offering some respite to both the chancellor and sterling. While this rout in Britain’s bond market is largely in step with the broader global sell off in sovereign debt, home-grown fiscal risks are not helping matters either: the spread between the 30-year gilt yield and its T-bill equivalent has widened by around 14 basis points since 12 August. Even so, the rise in borrowing costs comes at an awkward time ahead of the Autumn Budget. Higher yields erode the chancellor’s fiscal headroom, making it harder for Labour to balance the books while still pushing through their expansionary fiscal agenda.