For forex traders, Thursday’s Jackson Hole speech by Federal Reserve Chairman Jay Powell is the most important event risk this week. Despite a continued rise in U.S. yields, investors sold U.S. dollars ahead of this big event. The greenback experienced its biggest decline against sterling, the New Zealand and Australian dollars. USD/JPY shrugged off better than expected durable goods numbers to trade back down towards 106.00. Economists are calling this speech “profoundly consequential” and probably “historic,” according to CNBC.
Here’s what we know:
1. Powell will confirm that the U.S. needs ongoing policy accommodation: Regardless of the improvements in home sales or durable goods, the economy is in the dumps. Millions of Americans are out of work and businesses are going belly up. There’s more economic activity now than March, but the economy won’t be anywhere near pre-COVID levels until 2022 at the earliest. So the spigot needs to remain open and cheap money needs to keep flowing. There will be no surprise on this front.
2. Powell’s outlook will be cautious: The momentum in the U.S. economy is slowing. After snapping back smartly in May and June, recent data shows the pace of recovery easing. President Donald Trump passed an executive order to extend the extra unemployment benefits, but so far Arizona is the only state making payments. Other states said it could be between three to eight weeks before the infrastructure is in place to begin disbursements. For now, Powell needs to be mindful of the fact that retail sales could feel the pinch from thinner American wallets.
3. Inflation targeting is what everyone is talking about: Yet, the big historic conversation that is happening surrounds inflation. Consumer prices have undershot the central bank’s target for most of the past decade. This week, Powell is expected to outline the central bank’s plan to drive inflation higher, which represents a dramatic change from the Volcker period when the focus was on taming price pressures. There’s talk that he could use the term “average inflation targeting,” which would imply that the Fed could allow CPI to exceed 2% in order to keep average inflation at that rate. Language like this would be positive for stocks and negative for the dollar, as it means the central bank will allow monetary policy to remain accommodative for longer than necessary.
The New Zealand dollar benefitted the most from U.S. dollar weakness, which is impressive given softer trade data. The country’s trade surplus narrowed on the back of lower imports and exports. The government extended lockdown restrictions through the weekend and the Reserve Bank is dovish. Nonetheless, NZD has come back strongly on the market’s view that the government will beat out COVID-19 quickly. Sterling and the Australian dollar also rose sharply on anti-dollar flows. Concerns about oil helped to drive the Canadian dollar higher as Hurricane Laura is expected to be the biggest threat to U.S. oil refineries in 15 years.
The euro, on the other hand, underperformed. It saw very little gains against the greenback. Virus cases are on the rise in Germany, Italy, France and Spain, with Italy reporting the largest one-day increase since May. There’s less concern because the death rates are lower, but if this pace keeps up, governments may need to opt for broader rather than localized restrictions. The euro’s rally has been capped by the potential consequences of a second wave.