Fed credibility on trial

While the data calendar outside the US proved a little busier last week, the dollar still stole the show, albeit unexpectedly. As of writing late on Friday, the DXY index looks set to end the week more than a full percent lower, with the US Treasury responsible, on this occasion, for greenback underperformance. Wednesday’s announcement that the Treasury would more than double its purchases of long-dated bonds took markets by surprise. While, in principle, any "twist" operation should ultimately be cash-neutral, increased pressure on the Fed to suppress short-term rates raises independence fears, alongside concerns around a growing willingness to tolerate above-target inflation.

With that in mind, Fed credibility is likely to be on trial in the week ahead, overshadowing an otherwise light docket of events including an NBH rate decision and Australian inflation data. Rather, the Kansas City Fed's annual economic policy symposium in Jackson Hole now takes on additional significance, especially Chair Warsh’s keynote speech on Friday. Ordinarily, we would anticipate some hawkish pushback, and reassurance that the Fed remains ready to respond forcefully if needed. That, however, looks somewhat trickier, given Warsh’s preference for not offering forward guidance, and a refusal, so far at least, to detail a coherent reaction function. Such reticence, against the current backdrop, risks being seen as an endorsement of market fears. As such, while a wide range of dollar outcomes look possible in the week ahead, we see greenback risks skewing asymmetrically toward further weakness.

You can read the Week Ahead in full here:

Authors:

Nick Rees, Head of Macro Research

Barry van der Laan, Senior FX Market Strategist

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