The new Fed Chair appears determined to let the markets do part of the central bank’s job of bringing inflation back to target. According to Kevin Warsh, this process is already underway, as reflected in rising Treasury yields. Let’s discuss this topic and make a trading plan for EUR/USD.
The article covers the following subjects:
Major Takeaways
- Markets do not know how to handle their newfound power.
- The number of hawkish FOMC dissenters is growing.
- The odds of a rate hike are declining.
- Rebounds from 1.1470, 1.1550, and 1.1585 will provide selling opportunities for EUR/USD.
Weekly Fundamental Forecast for Dollar
Kevin Warsh has handed the steering wheel to the markets, but they do not know what to do with it. According to the new Fed Chair, the Fed’s decision to abandon forward guidance is not intended to catch markets off guard. Markets should react to incoming data rather than trying to predict the central bank’s next move. This shift in thinking has produced the first paradox: the number of hawkish FOMC officials is increasing, yet the odds of further monetary tightening are falling. That has weighed heavily on the US dollar. The question is: for how long?
US Treasury Yield Trends
Source: Bloomberg.
Kevin Warsh first introduced the “watch the data, not the Fed” approach in June. In July, the new Fed Chair said it was proving effective. Treasury yields are higher than they were 42 days ago, while inflation expectations remain close to the desired level. Does that mean the strategy is working? Are the markets doing the Fed’s job by helping slow inflation?
Not quite. The sell-off in stock markets, the surge in Treasury yields, and the decline of the US dollar suggest the opposite—the markets are worried about inflation. More specifically, they doubt their own ability to contain inflation without tighter monetary policy. Investors interpreted Kevin Warsh’s intention to delegate part of the Fed’s job to the markets as a sign that the central bank would continue delaying rate hikes. As a result, the probability of a September rate increase fell from 75% to 65%, becoming the main driver behind the EUR/USD rally.
Federal Funds Rate Target
Source: Wall Street Journal.
The problem is that Kevin Warsh’s new approach to getting others to do part of the Fed’s work is still poorly understood by other FOMC members. Many remain undecided, while three Fed officials openly question the effectiveness of the new approach. Neel Kashkari, Beth Hammack, and Lorie Logan voted in favor of raising interest rates, marking the largest group of hawkish dissenters since September 2016.
Goldman Sachs noted that the Fed is becoming increasingly hawkish as its patience with elevated inflation wears thin. JPMorgan went even further, arguing that Kevin Warsh once again failed to clearly explain how he intends to fulfill his promise of bringing inflation back to target. According to the bank, Warsh’s failure to clearly explain his strategy is likely to make the rest of the FOMC more determined to act in line with their mandate. I tend to agree. The Fed is not a one-man show.
Weekly Trading Plan for EUR/USD
In my view, EUR/USD is repeating the same mistake it made in June. At that time, the pair declined after markets interpreted Kevin Warsh’s rhetoric as hawkish. Disappointment then triggered a rally. This time, markets have interpreted the new Chair’s remarks as a signal that the Fed intends to do nothing. That interpretation is equally misguided. This repeated mistake provides an opportunity to sell the euro either from the upper boundary of the 1.1370–1.1470 consolidation range or on rebounds from the 1.1540 and 1.1585 resistance levels.
This forecast is based on the analysis of fundamental factors, including official statements from financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also considered.
Price chart of EURUSD in real time mode
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