Jerome Powell left very little doubt about the likelihood of Fed cuts in the immediate future last week.
Testifying to lawmakers, Powell said that uncertainties around global growth were weighing on the US economy, while the outlook for inflation in the US remained “muted”.
Combined with the admission that rate cuts would tighten financial conditions due to current market expectations of easing, Powell’s testimony gave the strong impression that the Fed would ease multiple times in the coming months.
Markets were already pricing an extraordinary level of easing prior to last week, with December FOMC dated OIS suggesting expectations of three 25bp cuts by then, but last week’s testimony looks to have been taken as confirmation by markets, with USD selling off.
How durable the Fed’s dovishness will prove remains to be seen
US macro data remains solid, apart from a likely contraction in the externally orientated manufacturing sector – suggesting the Fed’s incoming cuts are opportunistic, and enabled only by the softness of the medium term inflation outlook.
Considering Core CPI inflation is already above 2%, and the widely followed Dallas Fed Trimmed Mean inflation measure is also near this level, the Fed’s view that the inflation outlook is “muted” may not remain in place enough to justify the deep, consistent cut cycle that’s currently being expected by markets.
This suggests risk will remain tilted solidly to the upside for USD both in the near and medium term, unless US data begins to deteriorate rapidly.
This week’s data offers several interesting tests of this assertion, with Retail Sales out on Tuesday alongside Industrial Production and Business Inventories.
Chart: USD pares back early June rally
Survey data including the Empire State Manufacturing Index (Monday) and the Philly Fed Manufacturing Index (Thursday) is likely to be negative this week due to its manufacturing orientation.