USD: Guided by the Fed’s expectations - BBH

The dollar fell sharply at the end of last week as a fair hearing of both Yellen and Draghi's speeches at Jackson Hole shows neither addressed near-term monetary policy.  

Key Quotes

“The December Fed Funds futures contract was unchanged on Friday and for the week as a whole.  Bloomberg's model suggests a 34.7% chance of a hike by the end of the year is discounted.  In the CME's assessment, the market has priced in a 40% chance.  Our calculation, which assumes no chance of a hike September or November, puts it at a 38% probability.”

“The fact that the neither Yellen or Draghi addressed monetary policy means that the information set of investors did not change.  The status quo persists, and that status quo is dollar negative.  The status quo, in the consensus narrative, is that the ECB is about to take another step toward the exit, supported by a strengthening economy.  The status quo includes doubts about whether the Fed can raise interest rates again this year, or under Yellen's leadership.”  

“Could a newly appointed Fed chair lift rates early in their tenure if they were selected knowing the White House's preferences?  Inflation expectations would rise, but isn't that partly what officials desire?  The 10-year breakeven fell from just below 2.0% at the end of last year to 1.75% now.  It had fallen to 1.67% in the middle of June, the recovery stalled earlier this month.  The persistence of the status quo could see the 10-year breakeven fall to new lows, which would be consistent with the continued unwinding of the so-called Trump Trade, and the 10-year yield falling further.”  

“Presidential pardons are rarely the stuff for macroeconomic and foreign exchange analysis, but this time is different because the context is different.  The context is that Trump's handling of the recent white nationalist-inspired violence that seemed to suggest a moral equivalency estranged the business wing of his coalition.  Several such advisory panels imploded with resignations.  Others have been shuttered.  The pardon was for the controversial Sheriff Arpaio.”

“Then, on a different front, in a strongly worded letter, nearly a dozen business leaders threatened to withdraw support for the President in renegotiating NAFTA if the trade tribunals, which the Trump Administration has argued undermines US sovereignty, are abandoned.  At the same time, several of the departures from the White House have jettisoned the personnel link between the Trump Administration and the Republican Party.  The weakening support from the business community and increasing strained relationship between the administration and the Republican Party does not bode well for the policy outlook or the investment climate.”  

“The pardon may bolster Trump's base, but the challenge now is to increase it to govern.  The pardon will not help Trump mend any fences or strengthen his negotiating position.  His economic adviser and Director of the National Economic Council publicly was critical of Trump's handling of the past couple of weeks.  Cohn appeared to have considered resigning but thought his duty was to serve whilst expecting an improvement.  The pardon throws fresh gas on the fire.”  

“At the same time, the main strategy of tax reform has changed.  In the high frequency news cycle, this is easy to drop off the radar screen.  But, rather than provide a detailed tax reform plan, as has been promised would be delivered shortly, the White House is withdrawing from the process.  Recall that the process was to be led by a group of six high placed officials, Mnuchin and Cohn representing the Administration, and top Republicans in the House and Senate (Ryan and McConnell) and the two key Republicans for writing the bill (Brady and Hatch). Before the weekend, it was announced that (in essence) Mnuchin and Cohn would not be participating.”  

“At the same time that President Trump is more critical of the Republican leaders, he has pulled back from shaping his signature initiative.  It would seem to suggest a lack of confidence in success, and it will allow the President to campaign against the "do nothing" Congress in the primaries early next year.  Last week, Trump threatened to allow the government to shut down unless Congress authorizes money for the Wall with Mexico.  Last week's developments would seem to undermine rather than strengthen the likelihood of tax reform, and a smooth increase in the debt ceiling (or face potentially missing a debt payment) and new spending authorization (without which parts of the federal government would close).  A close call in 2011 led to the S&P's decision to take away its AAA rating.”