Muted Trade Ahead of Warsh Remarks

MACRO FRAME

Fiscal dominance has returned to the market, though underlying concerns over the deficit and debt burden are driving investors to demand more risk premium in an environment with persistent inflation. Meanwhile, yields have broadly taken a backseat to equity market performance as corporate earnings growth and expectations have set up bullish conditions to continue through the remainder of the year.

STOCK INDEX FUTURES

Equity index futures were muted overnight as markets await Fed Chair Warsh’s remarks at the Fed’s Jackson Hole Symposium for potential clues on the bank’s next move. The market is looking for more clarity regarding the bank’s reaction function given Warsh’s abandonment of forward guidance, raising questions over what inflation threshold is required for the Fed to move higher and how the bank views the rise in long-end yields. The shift today is from earnings validation back to focus on the macro environment. On the macro level, this week’s July PCE and revised Q2 GDP figures are hawkish and likely to affirm views on the FOMC board that policy should move upwards. Nvidia’s earnings strengthened the bull case for the AI infrastructure cycle. Nvidia reported fiscal Q2 revenue up 106% YoY, with data center revenue accounting for 93% of total sales, and up 117% YoY. 2028 revenue guidance projected a 70% YoY growth, as the company expects demand to remain firm with memory-component shortages continuing to provide bottlenecks. This could cap the pace of industry expansion, but it also reinforces the case for ongoing demand across memory, storage, networking, and data-center infrastructure.

CURRENCIES

US DOLLAR: The USD index is little changed at 99.19 as traders await remarks from Warsh later in the morning. Any comments that affirm or signal the bank’s intent to tackle inflation by raising policy are likely to strengthen the dollar. Additionally, the market will also be looking for comments on the Treasury’s recent move, signaling from Warsh that the bank remains fully independent should also strengthen the dollar in this case. This week’s PCE and revised Q2 GDP data affirmed inflationary pressures in the economy and showed that the US economy continues to outpace other major economies, which could offer the dollar a tailwind in the medium-term. Still, near-term rate hike expectations are likely to dominate price direction, while the markets lack of conviction toward a September hike keeping the dollar from breaking out higher despite this week’s hawkish data. The dollar remains under pressure from moves to diversify away from the currency amid worries over the deficit and the Treasury’s move to try and cap yields at the long-end of the curve. For the market, if bond prices cannot move lower naturally, the foreign exchange price of owning US debt will price it out via currency depreciation.

Watch point: The market remains doubtful over a September hike, though the risk of a move upwards in policy should not be discounted given the current inflationary backdrop.

EURO: The euro is little changed at $1.1644. Data out overnight showed inflation rose in France and Spain in August, mainly driven by higher energy prices. EU-harmonized inflation rose to 2.7% in France, while Spain’s rate landed at 4.5%, a two-year high. Given that a September hike is being taken as a sure thing by markets, any hawkish shift in pricing toward the Fed will be favorable weigh on the euro. The Reuters report that ECB policymakers are ready to raise rates at the September meeting was notable for the fact that the report said policymakers will signal little intent to further rate hikes beyond September. Money market pricing has not reflected the sentiment of the article, still pricing around 41 bps of tightening this year likely because the ECB remains in a favorable position to adjust on policy. Favorable data in recent months has shown the eurozone economy to prove resilient in the face of higher natural gas prices, which is likely to keep policymakers confident that the economy can withstand additional rate hikes without materially increasing risks to the labor market or consumption.

Watch point: Broader price direction will be subject to Fed-ECB policy expectations, which is likely to be favorable to the EUR in the near-term.

BRITISH POUND: Sterling is little changed at $1.3582. While recent economic data has portrayed a stronger economy than expected, the case for a rate hike from the Bank of England remains wary. Cooling hiring demand and moderating wage growth are reducing near-term inflation risks and factors the BoE will likely acknowledge in upcoming policy meetings as an argument against tightening. Markets have are no longer fully priced for a hike by year-end, seeing 24 bps of total tightening. Attention will shift to the parliament resuming session next week, where traders will look for signals on how the Burnham administration is likely to fund certain policies, ahead of the October budget.

JAPANESE YEN: The yen slipped 0.14% to 159.62 yen per dollar. Fresh data overnight showed unemployment (2.4%) fell in July to its lowest level in a year, while Tokyo’s inflation rate rose to a five-month high in August. Headline inflation remained below 2% as fuel subsidies and favorable base effects limited the impact of higher raw material costs. However, a gauge excluding fresh food and energy costs and viewed more favorably by the BoJ rose to 2.0% YoY. Bank of Japan Deputy Governor Ryozo Himino offered hawkish comments as expected and did not rule out a September rate hike, though gave little clarity on the pace of future increases. Himino highlighted that growing inflationary pressures could see underlying inflation exceed 2%. Himino also pushed back against the idea that future rate hikes could damage the economy, suggesting that financial conditions remain loose. Markets are pricing a 68% chance of a September hike. Failure to hike at the September meeting would renew pressure on the currency and send the yen back toward the 162 area. Stronger near-term rate hike expectations have kept the yen from sliding as fast as it had been earlier in the summer. However, existing fundamental pressures remain in the form of mounting unease over Japan’s fiscal outlook and debt-load.

Watch point: Failure to raise rates at the Bank of Japan’s September meeting could see the yen drop toward the 162 level.

AUSTRALIAN DOLLAR: The Aussie is little changed at $0.7197, near its 3-month high as traders continue to add to expectations of a September rate hike following monthly inflation data, which showed prices rose 1.0% in July. The Aussie has gained over 1% in the past week and over 3% in the past month and technically is nearing its May 2022 high of $0.7277. Recent data has suggested that inflationary pressures in the economy have not subsided to the degree in which the Reserve Bank of Australia had expected, prompting markets to reassess their outlook on RBA policy. Household spending rose 1.1% in July, against expectations of a pullback in spending, suggesting strong consumer demand despite higher borrowing costs. Meanwhile, July’s CPI print saw the trimmed mean measure of inflation rise 0.5% to keep the annual pace at 3.6%. Both figures are likely to be a point of concern for the RBA and could fuel the hawks on the board to raise rates once more by year-end. August’s meeting minutes showed that several members were pushing to hike rates, however, noted that upcoming data on inflation, jobs, and GDP ahead of September’s meeting would be needed to further assess the economy. Taken together, this has set up September’s meeting to be more lively than expected. Money markets now see a 57% chance of a hike at the September meeting vs. pricing of 40% on Tuesday and a 14% chance Monday.  Weak labor data has suggested some softness in the labor market, though the data is unlikely to weaken the RBA’s tightening bias heading into Q3 inflation figures.

Watch point: June’s hiring figures have offered some relief on inflationary pressures, though ongoing pass-through into broader prices is likely to be in focus in upcoming data.

TREASURY FUTURES

Yields are modestly higher across the curve ahead of Warsh’s remarks. Focus remains centered on Warsh’s Jackson Hole, and while he is not expected to offer much forward guidance, the market continues to look for an explanation on his opinion of the economy. Warsh’s lack of action on rates has not met his rhetoric, which has heightened the attention to his comments today. Focus will also center around any remarks on the Treasury’s buyback plans. Warsh has previously advocated for the Fed to play a smaller role in the market place, so any break from this stance in the form of support for the Treasury’s move is likely to trigger a negative reaction in the market.

Recent data this week has fallen into the hawks camp, with July’s PCE print, showing both headline and core PCE readings rise, while second-estimate GDP figures revised private domestic final demand higher to 4.2%, real GDI up to 2.2%, and quarterly PCE also revised higher. The report largely reflects that the economy retains enough domestic-demand resilience to keep inflation risks elevated. Inflation expectations continue to remain contained, signaling that upcoming bond market volatility is likely to center around the political environment in the US and November mid-terms.

Watch point: For Fed policy, without any forward guidance, the September decision will likely remain a close call.

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