It is not an exaggeration to say that the future of the markets is now tied to Powell’s Jackson Hole speech. Much more so in the currency market, which is often influenced by interest rate trends and expectations. The Fed chairman will be speaking shortly after the start of the New York session today. On Thursday, there were three speeches from the Fed hawks – Bullard, Kaplan, and George. Their comments were quite specific, pointing to the pace of reduction in purchases (15 billion a month) and the desired date for completion of these purchases (end of the first to second quarters of 2022) to have room to raise rates as early as next year.
These estimates are noticeably more hawkish and decisive than the market anticipated and put into expectations. Nevertheless, the reaction has been relatively muted, with the dollar index adding 0.3% by the end of the day but losing more than half that today; the S&P500 was down 0.7% by Asian session open but is now up 0.35% from those lows.
Investors have heard one camp and expect to listen to a much softer stance from the chairman of the US Central Bank. He is expected to advocate a less specific view on timing and emphasise that FOMC decisions at the end of September will be based on the data and forecasts available at the time. Simply put, Powell will surely leave the door open for a later tapering. By and large, the markets fear that Powell will repeat the hawkish position or come very close to it. This can cause a severe spike in volatility in the stock markets, potentially triggering a noticeably deeper correction, above 5% or even 10%.
Don’t get set up for a bear market started in stocks, as tapering is a smooth reduction in support in an economy that is already on a de facto path of self-sustaining growth. Experience with previous tapers in the US and Europe suggests no threat of a bear market in the next few years, aside from some increased frequency of corrective pullbacks.
The story with dollar dynamics is a bit more complicated. The US is often the flagship of monetary policy, and other central banks join in with some lag so that we might see an acceleration of the Dollar’s rising trend. Technically, the US currency has completed phases of declines and consolidation in a sideways range. Still, the markets are waiting for a wave from Powell or the Fed, giving the start of a DXY rally. There is also a slight possibility of negative surprises for the Dollar if Powell takes an extreme dovish stance. In that case, the stock markets would continue to storm to highs (nothing new here), and the Dollar would turn sharply lower. In that case, the DXY could quickly return to the lows of the year, near multi-year lows.