Powell’s Jackson Hole speech could send sell signals for the dollar

After holding back on immediate changes to the path of monetary policy in July´s meeting, the minutes of the FOMC revealed that the Bank is likely to strengthen its forward guidance on the back of a challenging recovery outlook. Markets have been increasingly pricing in the prospects of low real yields on the back-end of the yield curve, with a certain form of accommodative forward guidance expected at some point in the near future. The move, however, is strictly linked to the strategic review carried out by the Fed over the last year, aiming at re-anchoring market´s expectations on the inflation goal. The central bank first indicated a 2% inflation target in 2012, under which overshooting inflation expectations would prescribe restrictive monetary policy actions – a source of dollar strength. However, a lower-than-desired average inflation print of around 1.4% since the target was introduced suggests a softer goal around the target is recommended in order to re-centre investor´s expectations. As a result, the groundwork for lower-for-longer interest rates could be laid out, feeding the recent dollar weakness narrative, as the Fed is likely to outline its choice for a symmetric inflation target more commonly known as average inflation targeting.

Investors have been calling for further clarity on the Fed´s next plans, with much of the attention pushed back to the September FOMC meeting. The still uncertain scenario laying ahead, especially regarding the extent of the upcoming fiscal support package to be approved in Congress, provides some rationale to the Fed´s reluctance to release its policy review and commit to a new monetary framework. This is also the main argument to our view that it might be premature for Powell to make a clear policy statement in the Jackson Hole presentation next week. However, the event might be taken as a prepping exercise before the next scheduled meeting on mid-September, triggering an adjustment of market pricing ahead of a clear-cut policy announcement. Messages in this direction could come in the form of how the board consensus is evolving on the framework review, while probably deflecting on too specific wording.

Whatever the extent of explicit forward guidance, the direction of Powell´s speech towards a looser policy stance should assure markets of their recent dollar downward bias. Implications for financial markets could be broad-base, potentially fuelling an even larger equity rally and dollar depreciation. EURUSD one-week implied volatility in futures market does not currently price in a strong upside move on the back of the event, which suggests ample room for downside dollar correction next week if Powell actually signals a shorter time frame for upcoming Fed´s moves or delivers a more explicit monetary policy speech.