US inflation data came in broadly in line with forecasts. However, the modest month-over-month rise in core inflation sparked some market volatility. Kevin Warsh’s speech at Jackson Hole offers insight into the market’s reaction. Let’s take a closer look at the implications and develop a trading plan for the EUR/USD.
The article covers the following subjects:
Major Takeaways
- The market is confident that the Fed will raise rates.
- Investors are assessing the potential extent of monetary tightening.
- Kevin Warsh has tied his own hands by proving himself to be a hawk.
- Short positions on the EUR/USD pair can be opened with targets of 1.1505 and 1.1465.
Weekly Fundamental Forecast for Dollar
The Fed has effectively trapped itself. Had Kevin Warsh not come across as a hawk at Jackson Hole, the modest 0.3% month-over-month increase in core inflation would hardly have been enough to trigger a strengthening of the US dollar. However, the Fed chairman’s statement that he had not been misled by the June and July data showing a slowdown in consumer prices prompted the derivatives market to raise the probability of a monetary policy tightening in September from 70% to 86%. At one point, the odds exceeded 90%. This dealt a significant blow to the EUR/USD.
US Inflation
Source: Wall Street Journal.
Kevin Warsh finds himself in zugzwang: any move he makes is likely to leave him in a weaker position. Raising interest rates just seven weeks before the midterm elections would provoke fierce opposition from Donald Trump. Keeping rates at their current level, however, could undermine confidence in the Fed. The new central bank chief is unlikely to want to go down in history as the man who succumbed to pressure from the US president. Even if he wanted to accommodate the US administration, it would be difficult to do so without damaging his credibility.
The only way to curb the derivatives market’s expectations of a continued monetary tightening cycle after its expected restart in September would be through explicit forward guidance. Yet Kevin Warsh has made it clear that he does not want to send such signals to the market. Otherwise, one could argue that the current tightening cycle is merely a reversal of the previous monetary stimulus. After all, interest rates were cut at the end of 2025. In that scenario, investors would likely limit their expectations to two or three rate hikes, leaving little room for significant further appreciation of the US dollar.
Market Expectations for Fed Funds Rate
Source: Bloomberg.
Ahead of the FOMC meeting, the derivatives market suggests that the Fed must see through the line of argument it has started. In other words, a federal funds rate hike appears to be a foregone conclusion. However, FOMC members likely do not believe a single rate hike can bring inflation under control. Several rate hikes will likely be required. Kevin Warsh is unlikely to give a clear answer on how many hikes may be needed at the press conference, particularly given the intense political pressure on the Fed.
Instead, investors should look for clues in the FOMC’s updated economic projections. Given the surge in oil prices following the escalation of the conflict in the Middle East, it is reasonable to expect the Committee to send hawkish signals regarding the future path of monetary policy. This is allowing the US dollar to strengthen ahead of the Fed meeting. In other words, the greenback is being bought on the rumor.
Weekly Trading Plan for EUR/USD
Strong US inflation data for August allowed traders to add to short positions in the EUR/USD established at 1.1640. Expectations of a Fed rate hike, along with hawkish FOMC projections, support maintaining these positions. If the EUR/USD consolidates below 1.1570, the risk of a further decline toward 1.1505 and 1.1465 will increase.
This forecast is based on the analysis of fundamental factors, including official statements from financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also considered.
Price chart of EURUSD in real time mode
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