Dollar rally takes a breather as investors digest hawkish Warsh

Fed Chair remains concerned about inflation 

Despite some expectations for a low-key appearance from the current Fed Chair, partly aiming at reducing the importance attached to the Jackson Hole Symposium, Warsh did not disappoint in his speech on Friday.

While repeating that the 2% inflation target is firm and fixed – cancelling rumours about a shift in the goalposts – Warsh revealed his angst about the inflation outlook. He acknowledged the lower inflation readings over the summer but is still unconvinced that inflation is moving “quickly and clearly” towards the 2% Fed objective. Interestingly, he also stated that he cannot describe the current broad financial conditions as restrictive, thus devaluing the argument that bond markets have been doing the tightening and therefore limiting the need for action from the Fed.

Consistency and credibility seem to be the motto of Fed Chair Warsh, as he remains focused on meeting the inflation objective, during a period when the labour market is mostly healthy and not inflation-producing. However, he did not comment on the hot topic of Treasury buybacks, failing to disperse rumours about an unofficial agreement between the Fed and Bessent about extensive bond purchases as long-term Treasury yields continue to rise.

Fed hawks rejoice

Warsh’s persistent hawkish stance surprised both major markets and investment houses. Chances of a 25bps rate hike in September have jumped from around 33% before Warsh’s speech to the current level of 60%, with most US-based investment banks acknowledging the higher probability of a surprise move in two weeks’ time.

The initial market reaction was risk-negative, with US stocks, bitcoin and gold edging lower, as the US dollar posted gains across the FX spectrum, with the more pronounced move recorded in euro/dollar. The pair experienced the largest daily decline since mid-June and is currently hovering below the 1.1600 level. Interestingly, dollar/yen climbed above 160 again, for the first time since the late-July currency intervention.

US equity indices are stabilizing today, after a relatively low-volatility week. Similarly, gold is trying to find its footing after an almost $200 drop on Friday. The dollar rally could justify the price decline, but gold investors should not overestimate the chances of a Fed rate hike on September 16 as Fed doves still hold the upper hand in the FOMC. 

Jobs data to test hawkish expectation

Warsh has explained his current understanding of inflation, but this week’s jobs data and the September 11 CPI report for August hold the key for the September meeting. A strong nonfarm payroll report on Friday – recovering from last month’s negative print – and an upside CPI surprise might prove enough to tip the balance in favour of a rate hike at the mid-September meeting.

With UK markets observing a rare bank holiday today, following the improved Chinese Manufacturing PMI and the mixed Japanese data, the US events calendar is light today. However, investors should be wary of headlines from the G20 finance ministers’ and central bankers’ meeting, particularly from US Treasury Secretary Bessent following comments earlier today about reducing tariffs on Chinese imports.

Oil edges higher again

The oil market has completely ignored Fed Warsh’s speech and US President Trump’s announcement of the US taking over 17 oil fields in Venezuela, with a proven potential of 65bn barrels, partly because the extracted oil will mostly be directed towards filling up the US Strategic Petroleum Reserve and the military. 

While fresh military operations from US forces and a likewise response from Iran have pushed the spot WTI oil price above $85 again, the rally appears to lack momentum to test last week’s high.  While no one is surprised by these events, expectations for progress in the US-Oman-Iran negotiations have clearly taken another hit.