Downside risks for USD have increased following Jackson Hole

USD: Fed moving closer to cutting rates as threat to independence steps up

The US dollar has weakened modestly overnight resulting in the dollar index dropping back towards the 98.000-level. The US dollar has been undermined by a letter posted on Truth Social by President Trump in which he said he had “sufficient cause” to fire Fed Governor Lisa Cook for mortgage fraud. By firing Fed Governor Lisa Cook it would give President Trump the opportunity to have more influence over the setting of monetary policy at the Fed. He has already appointed Fed Governors Christopher Waller and Michelle Bowman, and has put forward Stephen Miran to temporarily fill the position vacated by former Governor Adriana Kugler. Stephen Miran is currently waiting for the Senate’s approval before begin able to vote on policy matters. If President Trump is successful in sacking Governor Lisa Cook, he would have the power to appoint a fourth governor to the seven person board of governors which would represent a majority. President Trump’s influence on Fed policymaking would then be reinforced further next year when Fed Chair Powell’s term comes to an end when he is also likely to step down from the board of governors although not confirmed.

However, Fed Governor Lisa Cook remains defiant and says President Trump has no authority to fire her. Her lawyer, Abbe Lowell has stated that they plan to make “whatever actions are needed to prevent” President Trump’s “illegal action”. Fed Governor Cook noted that “President Trump purported to fire me ‘for cause’ when no cause exists under the law, and he has no authority to do so…I will not resign. I will continue to carry out my duties to help the American economy as I have been doing since 2022.” Bloomberg has reported that Fed Governor Cook could immediately seek an injunction reinstating her while litigation moves forward. The relatively modest US dollar sell-off so far reflects in part uncertainty over whether President Trump’s decision to fire Fed Governor Cook will stand legally. It does though mark a significant step up in President Trump’s attack on the Fed’s independence which could eventually trigger a much bigger sell-off for the US dollar.          

The dovish signal from Fed Chair Powell at Jackson Hole does not appear to have satisfied President Trump’s desire for lower rates. Fed Chair Powell sent a clear signal that the Fed is moving closer to resuming rate cuts as soon as next month. He stated that “with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance”. It was in the context that “downside risks to employment are rising. And if those risks materialize, they can do so quickly in the form of sharply higher layoffs and rising unemployment”. The comments give us more confidence that the Fed will cut rates by 25bps in September if the release of the August NFP released in early September continues to reveal employment growth remaining worryingly weak. Fed Chair Powell acknowledged that the Fed faces a “challenging situation” with risks currently titled to the upside for inflation which favours more gradual rate cuts unless the labour market begins to deteriorate rapidly. Overall, the renewed downward pressure on short-term US yields combined with the increased threat to the Fed’s independence are both creating a negative backdrop for the US dollar supporting our outlook for further weakness in the year ahead.     

YIELDS SPREADS MOVING IN FAVOUR OF LOWER USD

Source: Bloomberg, Macrobond & MUFG GMR

EUR: French political uncertainty is on the rise acting as a dampener on euro

The other main development at the start of this week has been the announcement from French Prime Minister Francois Bayrou that he has agreed with President Emmanuel Macron to call parliament back into session early in order to allow the government to present its budget plan and hold a confidence motion. Prime Minister Francois Bayrou noted that “yes it’s a risk, but the supreme risk is doing nothing…there’s no getting out of this situation if we are not brave”. The government is facing pushback against their plans for EUR44 billion of spending cuts and tax rises including abolishing two of France’s public holidays. The far-left France Unbowed party, the Green party and the far-right National Rally have all said they will vote to overturn the government while the Socialist party have said they won’t support a vote of confidence. According to Bloomberg, should the parties that have announced their opposition to supporting a confidence motion follow through with votes against it on 8^th September that would be sufficient for force Prime Minister Bayrou to submit his government’s resignation.

The unfavourable domestic political developments could put a dampener on investor sentiment towards the euro in the near-term. The negative impact is already more evident in the French government bond market where the 10-year yield spread for French over German government bonds has re-widened back towards 80bps after trading closer to 65bps in early August. Over the last year the spread peaked out just below 90bps during the previous Budget negotiations in November. The euro also weakened during this period falling below 1.0500 although the main driver at the time was the initial fallout from the US Presidential victory for Donald Trump that encouraged a stronger US dollar. On this occasion we are not convinced French political uncertainty will be sufficient on its own to lower EUR/USD if the US dollar is weakening in response to Fed policy easing and the threat to the Fed’s independence.

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com