President Powell could have been very balanced, or even hawkish. But he effectively chose to support the market's opponent for a future rate cut. He had a strong reaction. Risk assets rose, the dollar fell, as did front-end yields. However, watch the longer-term yields - deep thinkers in the bond market are not entirely convinced that all cuts are good.
Disruptions on the horizon
President Powell in Jackson Hole:
"Inflation risks tend to be on the upside, and employment risks on the downside - a difficult situation. He noted that when our targets are under such stress, our framework calls for us to balance both sides of our dual mandate. Our policy rate is now closer to neutral by 100 basis points than it was a year ago, and the stability of the unemployment rate and other labor market measures allows us to proceed cautiously while we consider making changes to our policy stance. However, with policy in the restrictive zone, the baseline outlook and the shift in risk balance may justify an adjustment to our policy stance."
This was more hawkish than we expected in the interest rate strategy. He did not oppose a rate cut at all. It is clear he is keeping his options open, but the main move was to reduce inflation risks stemming from tariffs, largely due to a weak labor market. The market's significant reaction to the phrase "changing risks may warrant a policy adjustment" largely reflected increasing market fears that Powell might be explicitly hawkish in his speech. Front-end yields are lower (below 3.7%), likely structurally. The 10-year Treasury yield is also (near 4.25%). The probability of a rate cut in September has returned to 90%, after being below 70% before his speech.
There is a clear impetus for a downward yield curve from this. The front end is now aligned with President Powell, and yields there are expected to remain low. The market anticipates a final move towards a 3% effective fund rate, thus the two-year yield at 3.7% is still about 70 basis points above this future minimum. However, the long end does not favor this. The yield on the 30-year bond has returned to where it was at 3.9%. This likely reflects doubts that the Federal Reserve might risk inflation here.
The renewed threat this morning from President Trump to dismiss Federal Reserve Governor Lisa Cook (over alleged banking document forgery) is another factor to consider, as Trump's pursuit to turn the Federal Reserve into a hawkish entity continues. The front end won't care about this, as it is dependent on where the money market interest rate is heading. But the back end is deeper thinking and can worry about the effects of second and third rounds, especially regarding the medium-term risks that inflation may face.
The net effect here is a steeper curve, shaping up from both ends as the likely speculation for the future.
The dollar is taking a hit and more to come in the future#CryptoRally $BTC