- The risk of a spike in US inflation has fallen significantly.
- The likelihood of further weakness in the US labor market has increased.
- Markets increased the chances of a 50 bps Fed rate cut in September.
Currency futures soared on Friday as the dollar plunged after Powell said the Fed was ready to adjust policy. Powell’s speech conveyed that the Fed was ready to start lowering borrowing costs to ensure a steady labor market. However, by Monday, most currencies eased slightly as investors took profits.
After a whole week of anticipation, investors finally heard Powell’s tone regarding rate cuts. On Friday, the Fed Chair said the risks of a spike in inflation had fallen significantly. Meanwhile, the likelihood of further weakness in the US labor market had increased. Therefore, the Fed was ready to adjust its monetary policy in September.
The labor market drives a big part of the US economy. As a result, the Fed has kept a keen eye on this sector to ensure high interest rates don’t cause too much damage. However, recent data has started showing deterioration. The unemployment rate jumped more than expected last month and job growth slowed. This indicated cracks due to high borrowing costs. Therefore, it increased pressure on the US central bank to start its rate-cutting cycle.
The FOMC meeting minutes on Wednesday last week also revealed that some policymakers had considered lowering borrowing costs at the last meeting. Therefore, most officials have dropped their previous cautious tone, showing increased confidence that inflation will reach the 2% target.
After Powell’s speech, markets increased the likelihood of a 50-bps rate cut in September to 38.5%. The US central bank might consider a bigger cut if the next jobs report shows further weakness in the labor market.
The dollar’s decline on Friday allowed other currencies to climb. Notably, the pound rallied to an over two-year high amid upbeat UK data. Recent UK economic reports have revealed strength. British consumer confidence was near a three-year high, indicating a brighter outlook for the economy. This contrasted with the US where PMI data last week revealed a drop in business activity.
Yen per Dolla (Source: Bloomberg)
The yen also soared as Powell’s dovish speech contrasted with Ueda’s hawkish tone. On Friday, BoJ governor Kazuo Ueda said the central bank would not hesitate to hike interest rates. Initially, his deputy had noted that market volatility could hinder near-term rate hikes.
