Yellen’s Jackson Hole speech confirms further 2016 hikes, buoys Dollar

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30 August 2016

Written by
Enrique Díaz-Álvarez

Chief Risk Officer at Ebury. Committed to mitigating FX risk through tailored strategies, detailed market insight, and FXFC forecasting for Bloomberg.

The languid summer trading of the past two weeks suddenly perked up on Friday afternoon, as the long-awaited speech by Fed Chair Janet Yellen hit the wires.

O
f most immediate importance to the markets was the explicit statement that ‘the case for [US rate hikes] had strengthened’. In our view, this aligns with the consistently hawkish tone of recent communications from Federal Reserve officials and all but guarantees either one or two hikes in the remainder of 2016.

After some hesitation, markets responded to the unequivocally hawkish tone of the speech. The Dollar rallied, US treasury yields rose and stocks fell.

News out of the United States will continue to drive currency markets this week. On Friday, we will get the last major piece of economic news before the September Fed meeting: the US labour report for August. We expect another strong report that will push a majority of FOMC members into voting for a rate hike, thus providing strong support for the US Dollar in the next few weeks.

Major currencies in detail:

GBP

In contrast to the very weak business sentiment indicators, actual activity data in the UK has so far been stronger than expected after the shock referendum result.

The UK’s jobless claimant count in July registered a surprising drop and retail sales came in much stronger than expected. These are highly volatile numbers that provide only a partial picture of the UK economy.

However, the thesis, that the drop in Sterling will cushion the short-term economic impact from the referendum, is starting to gain ground. Sterling gained strongly against both the Dollar and the Euro, and it looks increasingly likely that the post-referendum lows against both currencies will hold for the medium term.

EUR

The flash Eurozone PMI index of business confidence was roughly stable at 53.3 in August.

So far, business managers appear to have taken the EU referendum result in their stride and confidence is holding around levels consistent with modest growth in the Eurozone as a whole.

However, this average masks large divergences across national economies. Spain is growing strongly, shrugging off political uncertainty as parties fail to form a Government. Meanwhile, Germany is steady and Italy seems unable to take off convincingly.

Absent any big surprises from this week’s Eurozone inflation release, we expect the Euro to continue treading water as investors grapple with the near certainty of at least one further Fed hike in 2016. This eventuality is still not fully priced into interest rate markets, though the gap between prices and Fed rhetoric has certainly narrowed in recent weeks.

USD

Yellen’s hawkishness at the Jackson Hole address was not unexpected, given the steady hawkish tone of Fed official announcements over the past three weeks.

The key development pushing Fed officials ever closer to a second hike is without doubt the strong showing in the US labour market. May weakness all but forgotten and the three month average of 190k going into Friday’s August report is considerably above any reasonable growth estimates.

With financial markets buoyant and financial conditions quite supportive of consumer and business spending, we see little standing in the way of two hikes in the remainder of 2016, one in September and one in December.

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