Black clouds are parting over emerging markets. The belief that the Federal Reserve will quickly and decisively abandon its crisis policies is one of the main sources of the holiday troubles for risky currencies and assets.
Throughout last week, the dollar lost value. Friday's symposium of central bankers in Jackson Hole could have been a chance to turn its fortunes around. In the past, conferences held at the Rocky Mountain resort in August have featured important statements on the future of US monetary policy, which traditionally determines the course of currencies and, more broadly, the sentiment on financial markets. As we expected, the meeting did not bring positive news for the dollar and market participants expecting fireworks were sorely disappointed. As a result, the EUR/USD pair jumped to 1.18.
Dollar bumped at resort party
So, what did the Fed chief actually say? First, he confirmed that the tapering of quantitative easing (currently at a minimum of 120 billion USD per month) should take place this year. Between the lines, however, we could read that it might be too early to announce this milestone in September - the upcoming labour market report may have a lot to say on the matter. Secondly, Powell once again poured a bucket of cold water over the heads of investors who were preparing for the fact that asset purchases would become a thing of the past immediately preceding interest rate rises. In our view, the priced-in valuation of such a move, which has supported the dollar in recent times, was premature, and the high expectations bar was the main reason why we viewed the outlook for the US currency negatively. Let us recall: our currency forecasts assume that the EUR/USD pair will rise towards 1.20 in Q4.
What is worth noting is that Jerome Powell continues to describe the nature of price processes in a very cautious manner. To put it another way: he sticks to his mantra that the rise in inflation is temporary. Although the labour market has recovered the lion's share of the 22.5 million jobs lost during the pandemic, the Fed chief is not overly optimistic about the health of this sector of the economy either. Concerns were also raised about the increasing number of coronavirus cases and its potential impact on the economic situation in services, which, after all, were by far the hardest hit by the pandemic restrictions. To summarise: tapering of asset purchases will start this year, but a very soft, dovish narrative will accompany it. First and foremost, one cannot assume an equal sign between gradual abandonment of quantitative easing (the process to complete tapering should last at least three quarters) and rapid (Q4 2022) interest rate hikes.
In this context, the information from Jackson Hole is negative for the dollar. This Friday, the labour market report for August will be published. Only if the pace of job creation from the previous two months is maintained (in June and July, over 900 thousand jobs were added each), hopes for announcing the decision to end bond purchases at the Federal Reserve meeting at the end of September will remain realistic.