USD remains resilient but for how long as downside risks mount?

USD: Resilient despite threats to the Fed’s independence   

The US dollar has so far proven surprisingly resilient in response to President Trump’s decision to fire Fed Governor Lisa Cook, and the dovish signal from Fed Chair Powell at Jackson Hole preparing the ground to resume rate cuts as soon as next month. The dollar index has almost fully retraced the initial sharp sell-off following Fed Chair Powell’s keynote speech on Friday and currently stands only around -0.3% lower. In contrast, the yield on the 2-year US Treasury bond has not rebounded and remains over 10bps lower reflecting more confidence that the Fed will lower rates in the coming years. The justification for the Fed to resume rate cuts as soon as next month was also supported yesterday by the release of the Conference Board’s consumer confidence survey revealed a further deterioration in labour market conditions. The index showing the differential between jobs plentiful and hard to get fell for the eighth consecutive month of this year, and hit the lowest level since February 2021 during the initial recovery phase following COVID lockdowns. The recent resilience of the US dollar could be a reflection that market participants are still waiting for stronger confirmation from the release of the August NFP and inflation reports that the Fed will follow through with plans to resume rate cuts next month.

Similarly, market participants are waiting to see whether President Trump has the legal power to fire Fed Governor Lisa Cook given it has never happened before. The Federal Reserve released a statement overnight in which they indicated that it would abide by any court decision in Governor Cook’s legal challenge of her dismissal. The Fed stated  specifically that “Lisa Cook has indicated through her personal attorney that she will promptly challenge this action in court and seek a judicial decision that would confirm her ability to continue to fulfil her responsibilities as a Senate-confirmed member of the Board of Governors of the Federal Reserve System”. At a cabinet meeting yesterday President Trump stated that he was also prepared to abide by any court decision but indicated he was not concerned by Governor Cook’s legal challenge. He added that he has some “very good people” under consideration to fill her position while giving away his desire to “have a majority, very shortly so that’ll be great” of Fed governors who have been directly appointed by himself. He even floated the idea that Stephen Miran  could take over the role permanently rather than taking up the temporary role vacated recently by former Governor Adriana Kugler.   

At the same time, Bloomberg is reporting that President Trump’s team is also weighing up options to extend their influence over regional Fed banks. The report adds that the Board of Governors is next scheduled to authorize the current roster of reserve bank presidents in a once-in-five-year exercise in February. If President Trump is able to secure a majority on the board of governors, it would give him more influence in scrutinizing how regional presidents are vetted and chosen since they are not confirmed by the Senate. It provides another indication that the Trump administration poses a serious threat to the Fed’s independence. It could give President Trump more influence over lowering rates, resetting financial regulation and adjusting the Fed’s balance sheet policies if he is successful that would have far reaching implications for the global economy and financial markets. We continue to believe that the worrying developments could eventually trigger a much bigger sell-off for the US dollar.  

USD REBOUNDS EVEN AS YIELDS REMAIN LOWER POST-JACKSON HOLE

Source: Bloomberg, Macrobond & MUFG GMR

AUD: Stronger Australian CPI report fails to lift Aussie

The other main economic development overnight was the release of the latest monthly CPI report  from Australia. The report revealed that inflation picked up more than expected in July rising to an annual rate of 2.8% up from 1.9% in June.  At the same time, the trimmed mean measure of inflation which excludes fuel prices and electricity bills rose to 2.7% in July up from 2.1% in June. It lifts the trimmed mean measure of inflation slightly higher than the RBA’s average forecast for Q3. The main driver of the upside surprise to inflation in July was electricity prices which rose by 13%M/M and now stand 13.1% higher than a year ago. It reflected an annual increase in electricity prices approved by regulators and the timing of the Australian government’s rebate extension.

However, the pick-up in inflation is expected to prove short-lived with the jump higher in July expected to reverse quickly in August. It helps to partly explain by the muted reaction of the Australian dollar to the upside inflation surprise overnight. AUD/USD has continued to trade in a narrow range just below the 0.6500-level. The pair has traded between 0.6400 and 0.6600 for almost four months now. The Australian rate market has moved to scale back expectations for further RBA easing although today’s CPI report has not significantly altered expectations for the next policy meeting in September when the RBA was already expected to leave rates on hold. There are currently only 5bps of rate cuts priced in by September and 33bps of cuts by year end. In comparison the Australian rate market was pricing in around 36bps of cuts by year end as of yesterday. The RBA has recently indicated that they continue to favour gradual rate cuts with current forecasts conditioned on a “couple more cuts”                

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com