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Dollar Hits Ropes after "Enemy" Powell's Shift Not Enough for Trump; Trade War to Escalate Imminently

© The White House

- USD hits ropes after Powell shifts, but not enough for Trump.

- Trump paints Fed's Powell as "enemy" on par with China's Xi.

- Threatens retaliation for China's own Friday tariff retaliation.

- More tariffs imminent, with possible Trump bid to weaken USD. 

The Dollar hit the ropes Friday after Chairman Jerome Powell hinted in Jackson Hole that the Federal Reserve (Fed) is slowly leaning toward further cuts to U.S. interest rates, but it came as too little and too late for President Donald Trump, who subsequently hit out at the bank via his Twitter account.

Dollar losses were amplified in late noon trading when President Trump hit out at Powell, describing America's most senior banker as the "enemy" and placing him on a par with Chinese President Xi Jingping before seemingly threatening to intervene in currency markets and weaken the greenback.

"The USD is sharply weaker this afternoon due to the latest attack from President Trump on Fed Chair Powell. On a day in which China has announced retaliatory tariffs on the US, the President has asked whether Powell or Chairman Xi is his bigger energy. On the back of his blistering outburst, the market is speculating whether Trump will take direct action to weaken the greenback," says Jane Foley, head of FX strategy at Rabobank.

Trump's comments and Powell's speech both came after China announced it will impose tariffs on around $75 bn of U.S. exports in retaliation against a White House decision earlier in August to  begin the process of targeting all its remaining exports to the U.S. not yet covered by levies from September 01. That came as another blow for the global economic outlook and prompted Trump to threaten an immediate response.

"While there has been some position adjustment this week our central view is that safe havens will remain well bid in the coming months and, assuming the Trump does not order the Fed to sell USDs, the greenback looks set to remain firm," Rabobank's Foley says.

Above: Dollar Index at 5-minute intervals, alongside the Pound-to-Dollar rate (black line, left axis)

Powell, who's been under pressure from the President and markets to cut U.S. interest rates aggressively in the months ahead, told an audience of central bankers at the Jackson Hole Symposium Friday "It will at times be appropriate for us to tilt policy one way or the other because of prominent risks," referring to the U.S.-China trade war.

In a speech titled "Challenges for Monetary Policy" Powell said the trade war is adversely affecting the outlook for employment and inflation, which could mean that it should also impact the path of U.S. interest rates but he also decried the unprecedented nature of the tariff fight and the resulting uncertainty about how great the impact will be and exactly what policy measures would be required in order to offset it. 

Changes in rates are normally made in relation to the outlook for inflation, which is sensitive to economic growth, but impact currencies because of the influence they have over capital flows. Those flows tend to move in the direction of the most advantageous or improving returns, with a threat of lower rates normally seeing investors driven out of and deterred away from a currency. Rising rates are used to reduce inflation and have the opposite effect.

"Inflation seems to be moving up closer to 2 percent," Powell told his audience, after noting the economy has experienced a protracted period of subdued inflation pressures. "There are, however, no recent precedents to guide any policy response to the current situation...We can, however, try to look through what may be passing events, focus on how trade developments are affecting the outlook, and adjust policy to promote our objectives."

Above: Dollar Index at daily intervals, alongside the Pound-to-Dollar rate (black line, left axis)

Powell's remarks could be perceived as a sop to the White House and its repeated, aggressive demands for the Fed to cut interest rates. The Dollar was already declining following those remarks, suggesting the market may have seen them as a sign of what's to come, but losses accelerated with President Trump's afternoon intervention via his Twitter account. 

"We don’t envy Mr. Powell and his colleagues right now; all their analysis and forecasts can be upended by a single tweet, so the policymaking process has been wrecked, even without the overlay of the president railing at the Fed like Lear on the heath, but less coherently. Still, nothing in this speech suggests the Fed will pause in September. The hawks have been vocal recently, but they seem still to be outnumbered," says Ian Shepherdson, chief economist at Pantheon Macroeconomics.

Fears on the FOMC have always been that a nascent global downturn will eventually hurt the U.S. through reduced demand for products made in America, although the Fed is constrained in the extent it can act by the elevated level of U.S. inflation and its statutory mandate to use interest rate policy to keep price pressures contained. However, since the July rate cut the context has changed notably, with the U.S.-China trade war flaring again and U.S. bond markets beginning to warn of recession. 

Investors sold out of the U.S. bond market heading into Friday, prompting two-year yields to rise over and above those of 10-year bonds and driving another inversion of the yield curve, which represents the cost of government borrowing for maturities between one month and 30 years. It inverts when the market is anticipating that interest rates will be lower in the years ahead and is normally seen by analysts as a warning of recession. Selling continued on Friday, until Trump's attack on Powell.

When the Fed cut rates from 2.5% to 2.25% on July 31, Powell characterised it as a "mid-cycle adjustment", not the beginning of an 'easing cycle'. But his speech Friday suggests that viewpoint may be changing. And if it's not, it could certainly change over the coming weeks if the trade war escalates even further because of Friday's events.

"Tensions between the central bank, the US president, and market expectations are unlikely to be resolved soon. Since the turn of the year, the Fed has often appeared to be a step or two behind the market, adjusting its communication to become more dovish only after investors have discounted looser policy. As it stands, investors expect a further 100bp of cuts over the next twelve months. The Fed’s last projections, from June, only incorporated a single cut, which has already been delivered in July," says Jonas Goltermann at Capital Economics.


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