1st September - Warsh Gives Us a Hawkish Surprise
Updated: Sep 2
The biggest news over the course of the UK bank holiday weekend was Kevin Warsh's speech at the Jackson Hole Summit, which surprised everyone with hawkish guidance for future rate decisions. He argued that inflation was running too high and that price stability would be the Fed's main focus, noting the Fed 'had work to do'.
The markets reacted immediately, with September rate hike odds rising from just under 40% before to just under 60% after, then just over 60% as of yesterday. The USD rose and metals fell off the back of the move. An important point to note is that this potential plan to raise rates puts the Fed's plans in direct conflict with the US Treasury's goal of reducing bond yields. Higher interest rates will increase long-term bond yields as investors need higher returns to justify the investment, which will go against the goal of Secretary Bessent's plans to lower yields by buying longer-term bonds. Having two significant government institutions with directly opposing stances and plans cannot be beneficial for the US; which side wins will be an interesting thread to follow for the remainder of the year.
Outside of Jackson Hole, we also saw the first exchange of fire between the US and Iran since late July. The US launched strikes on Iran's Larak Island, before the Iranians reportedly struck against US bases in Jordan. Oil is now rising back towards the levels we saw at the beginning of last week, with Brent at $93.80 and US Oil at $86.10 this morning. The continually elevated oil prices are not helping the concerns around inflation and rate hikes as a result, meaning oil prices are once again going to be keenly monitored ahead of the next FOMC rate announcement on the 16th of September. We also need to start to look forward to the November mid-term elections in the USA; there could be a change in the majority party in Congress and potentially even the Senate, which will have a significant effect on how the US will be run.
Forex
Warsh's comments on Friday caused a huge move in the USD, with the DXY climbing to 99.68 by the weekend. We saw some of the move retraced yesterday as markets digested the information, but then saw some more positive momentum for the USD first thing today.
An interest rate hike is undoubtedly good news for USD bulls, at a time when there are so many competing influences a change in interest rate expectations is one of the cleanest catalysts there is. However, in the longer term, there is reason for concern with the USD, as two of its government institutions, the FOMC and the Treasury, have directly opposing goals. The FOMC is looking for inflation to fall towards 2% and will use interest rates to do so, while the Treasury is looking to reduce bond yields and will struggle to do that with higher interest rates. Unless one of these institutions shifts positions significantly, these competing forces may end up leaving investors choosing to just stay away from the US entirely, further damaging the US economy. The next few months will be very interesting indeed for the US, with the war in Iran continuing and the two competing institutions both potentially overshadowed by the upcoming midterms and the uncertainty that disputed results could cause. Risk-averse foreign investors may well just decide to stay away until the outlook is less choppy.
Looking past the USD, the only other currencies to really move over the past few days have been the AUD and the CAD, with both performing well. The AUD has been buoyed by increased rate hike expectations following higher-than-expected inflation figures last week, while the CAD has been riding the coattails of higher oil prices over the weekend. Both look likely to have another good week unless we see a catalyst to cut away some of their momentum.
Indices
The indices' moves were modest in comparison, with markets relatively flat on Friday after Warsh's comments. Markets did fall on Monday somewhat, but there were no extreme moves as of yet. All three of the indices had a positive month as a whole, with the Dow up 1%, the Nasdaq 100 up 3.42%, and the S&P up 2.17%. Considering the uncertainty coming from multiple sides, a positive month is no mean feat.
The fate of the indices for the next few weeks seems linked to both oil prices, thanks to the possible re-escalation of the Iran war, as well as whether we see a rate hike after all in September. The likelihood is now priced in at over 50%, so it's one to make sure to look out for.
Precious Metals
We have been waiting for a retracement for weeks; it has now arrived but with concerns to go along with it. The original cause of the fall in metals prices was the threat of rate hikes caused by inflation, thanks to the Iran war. These fears had receded somewhat over the past month, giving metals room to move higher. However, Friday and the weekend have pushed rate hike concerns firmly back into the picture and have hit metals hard. Gold fell 3.2% on Friday, and silver fell 4.2%. Both had a breather yesterday but are continuing to struggle so far today with Gold currently at $4,375 and Silver at $64.85.
We are currently coming into a very interesting area with gold. We have seen close to a 60% retracement of the move from last month, which is coinciding with a key level of resistance as well as the 200-day moving average. The key question now is whether the pullback is just a temporary reaction to Warsh's comments and the rate hike likelihood, if it is just a recalibration of expectations for the remainder of the year and a minor reality check, or could it be a larger and more significant change in sentiment? If we see rate hikes in September and comments implying we could see further hikes, the narrative around metals changes significantly, and we could see moves back to the lows we saw in July.
We are currently at a significant point in time for metals and a decision point for traders. Do we back metals and expect longer-term bullish movement, or are we expecting more rate hike concerns and higher oil prices for longer? Right now, it is difficult to know which way to lean.
This Week's Key Market Drivers
USD ISM Manufacturing PMI, 3pm UK time, 1st Sep - A key figure to understand the state of the US economy, this could lean into or away from rate hike concerns depending on the strength of the figures released.
AUD GDP, 2:30am UK time, 2nd Sep - After hot inflation figures last week, the AUD will react to how this release impacts rate-hike expectations in the short term.
NZD Interest Rate announcement, 3am UK time, 2nd Sep - The RBNZ is expected to hike by 0.25%. If this is the case, the news will come from the associated guidance.
CAD Interest Rate announcement, 2:45pm UK time, 2nd Sep - The BoC is expected to hold. As with the RBNZ, if they do, the market will be moved by any unexpected forward guidance.
USD NFP, 1:30pm UK time, 4th Sep - The blockbuster event of the week, this will have a significant impact on interest rate expectations and so the market as a whole.
CAD Unemployment, 1:30pm UK time, 4th Sep - This will be overshadowed by the NFP figures, but will still have an effect on the CAD itself.
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