US trading thematics: Part 1 “When Powell talks”

Over the coming 48 hours and then over the coming 2 weeks, Fed speak and US data is going to be some of the best trading opportunities in 2024. It’s been a pretty low-vol year despite several events that would under normal circumstances be triggers for much larger fluxes in FX and bonds. But to date: that has not been the case.

Let’s look at the first part of what will be a clear mover of the USD, bonds and US equities. Fed speak

First off let’s review day one of Federal Reserve Chair Jerome Powell two-day semi-annual testimony to the Senate and the resultant reactions.

To paraphrase the core, take outs from the testimony – Powell continued to spew out the lines around “inflation has significantly declined from its four-decade peak reached two years ago”. Yet  despite this improvement, “central bank officials require more progress before considering an interest rate reduction, while closely monitoring the job market.” 

Furthermore he also dropped this broken record line “We do not expect it will be appropriate to reduce the target range for the federal funds rate until we have gained greater confidence that inflation is moving sustainably toward 2%,” Powell noted in his prepared testimony to Congress. During the hearing, he refrained from predicting a rate cut this year or specifying its timing, unlike previous comments.

“The most recent inflation readings, however, have shown some modest further progress, and more good data would strengthen our confidence that inflation is moving sustainably toward 2%,” he added.

All this is known knowns but what did create interest for us traders was this line that lit bond and FX markets up like a Christmas tree

“Elevated inflation is not the only risk we face. Reducing policy restraint too late or too little could unduly weaken economic activity and employment.”

The reaction to this was clear, have a look at the impact this line had on the USD

DXY – 1 minute chart

AUD/USD at a 7-month high.

It is chasing the 28 December high now of $0.687. From a trading perspective, the US CPI data on Thursday coupled with the employment data in Australia on July 18 and Australia’s CPI data on July 31 that could confirm if the pair do reach this point – on current forecasts – it’s probable.

The catch (seeming we will see over the coming day) is US inflation that has only just stabilised with last month’s data showing there wasn’t a price increase for the first time since November. It explains why it’s hard to argue that ‘we are not at a sustainable level’.

It also explains why the dot plots for example are only one rate cut this year, down from the three forecasted in March. But the dot plots do highlight that once cuts begin – there is likely to be a steady slide in the Federal funds rate. Thus, the start will signal the possibility of 6 rate cuts by the end of that said cycle.

If we look at the Fed preferred measure of inflation, the Personal Consumption Expenditures (PCE) price index. It showed no monthly rise in consumer prices for the first time since November as well, with an annual rate of 2.6%, slightly down from 2.7% in May.

But as New York Fed President John Williams highlighted just last week “Inflation is currently around 2.5%, indicating significant progress, but we still have work to reach our 2% target consistently,” said.

This brings us to Thursday’s CPI data. Core CPI data is expected to land at 3.4% unchanged from the May read, headline CPI is expected to fall to 3.1% from 3.3% and would be near the June 2023 low of 3%. 

Watch this space to anything below these two estimates and the USD will be off to the races.

The other interesting part of Fed speak has been the pivot to employment and the risks of a ballooning unemployment rate.

Take for example Powell’s Senate testimony that the labour market has normalised but still faces risks. He compared the current job market to its pre-pandemic state, that being “strong, but not overheated.” 

This was backed up by showing that although the unemployment rate has risen to its highest level in over two years, employers continue to hire robustly. Couple this with the fact the gap between job openings and unemployed job seekers has significantly narrowed over the past year – a typical sign of a strong jobs market.

Senate Chair Sherrod Brown of Ohio however countered this with  “I’m concerned that if the Fed waits too long to lower rates, the Fed could undo the progress we’ve made in creating good-paying jobs,” 

Which brings us back once more to the statement the markets got most excited about – how long should it wait?

Powell acknowledged the Fed’s challenge of balancing the risks of rekindling inflation by cutting rates too soon against the potential weakening of the labour market by waiting too long. The Fed’s dual mandate is to stabilise prices and maximize employment, noting a recent shift towards a balanced focus on both goals.

Is this a signal that September is live? Trading in the rates market now put the September meeting at an even chance of the first cut. Consumer behaviour suggest that the Fed might have lower borrowing costs. US retailers have reported weaker-than-expected sales, and consumer demand has been tepid this summer compared to last year.

So that is what the Fed is seeing – now we need to see the actuals backing this view – thus Part 2 of trading the US will be a deep dive into the CPI data and if there is enough evidence we are ‘sustainably returning to target’.