Powell commits to restrictive policy until inflation beaten. Little market reaction. Lagarde says ECB will also stay restrictive

Global markets endured a choppy session on Friday as US Fed Chairman Powell addressed the economic symposium in Jackson Hole. He outlined that inflation is too high which will require rates remaining at the current level, or higher, to bring inflation down to its 2% target. The S&P gained 0.7% on the day resulting in the first higher weekly close in a month. Despite a short burst of volatility, the US Dollar was little changed while front end US treasury yields moved higher.

In a widely anticipated speech, Chairman Powell presented a cautious optimism on inflation while also reiterating that it remains too high.  He said the Fed is prepared to raise rates further if appropriate and intend to hold policy at a restrictive level until it is confident that inflation is moving sustainably towards its objective. Getting inflation back to target is expected to require a period of below-trend economic growth as well as some softening in the labour market.  While policy is considered restrictive, there was no discussion if the neutral policy rate has shifted following the pandemic. Powell pushed back against any change in inflation target which is currently being debated particularly amongst the academic community.

Overall, the speech didn’t alter market perceptions that the Fed will likely pause in September and assess the incoming data to guide future policy decisions. Market pricing for the September FOMC is little changed with a near 20% chance of a 25bps hike. There is a cumulative 15bp of tightening priced for the next 2 meetings. US 10-year treasuries ended little changed at 4.24% despite trading a whippy 9bp range. Meanwhile, front end treasury yields continued to move higher. 2-year maturities increased 6bps to 5.08% contributing to a flatter yield curve.

In Japan, headline Tokyo CPI for August, which is considered a leading indicator for the national gauge, was marginally below expectations at 2.9%. However, the core reading met expectations at 4%. BoJ Governor Ueda commented that underlying inflation is still a bit below its 2% target providing rationale for the Bank’s still ultra-easy monetary stance. 10-year JGB yields were little changed at 0.65% marginally below the recent 0.68% highs.

Business confidence in Germany remains depressed with the Ifo expectations index falling more than expected. This follows the release of advance PMIs last week where the composite index fell further below 50 to the weakest level since the pandemic. Q2 GDP was confirmed as flat for the quarter on Friday driven in part by weak trade. The current level of business sentiment suggests growth will be mildly contractionary through the next 2 quarters according to the Ifo Institute. Restrictive interest rates and slowing global growth, particularly China, are creating headwinds for the German economy. It is expected to be the only European economy to contract in 2023, according to consensus forecasts.

Speaking at Jackson Hole, European Central Bank President Lagarde said the Bank will set borrowing costs as high as required and maintain them at sufficiently restrictive levels for as long as required to return inflation to its 2% medium term target. Lagarde didn't add to earlier guidance about the September meeting being a hike or a pause. The market is pricing 10bp for the September meeting and a total of 17 bp by the end of the year.

In currency markets the US dollar whipsawed during Powell’s speech. The Dollar index tested lower initially before recovering sharply but ended little changed on the day and about 1% higher over the course of last week. The US Dollar index is now comfortably above the 200-day moving average and remains near 3-month highs.  The yen continued to lose ground against the Dollar amid higher front end US treasury yields. USD/ JPY traded above 146.50 to the highest level since November last year.  EUR/USD failed to garner much support amid generally hawkish commentary from ECB Governing Council members and ended the week near 1.08.

In a whippy offshore session, NZD/USD initially spiked up toward 0.5940 before quickly reversing course aligned with the moves in the US Dollar. NZD/USD slipped below 0.5900 to make fresh lows for the year before recovering into the weekly close. NZD/AUD dipped to the weeks low below 0.9200 in early European trade but rebounded to close near 0.9220. The latest CFTC currency futures positioning data, reveals that the speculative community have been selling Australasian currencies, likely related in part to weak activity in the Chinese economy.

NZ fixed income yields traded higher in the local session on Friday. There was a 5bps parallel shift in the NZGB curve while the front end of the swaps curved outperformed leading to a modest swap curve steepening. Australian 10-year bond futures ended the offshore session 3bps lower in yield from the local close on Friday while 3-year futures were little changed.

It is a quiet start to the week from an economic data perspective. The only data of note on the global calendar is Australian retail sales for July.