The US stock market was subdued, while the greenback inched up ahead of the speech by Fed Chairman Jerome Powell at the annual conference in Jackson Hole.
On Thursday, the key US stock indices retreated from historical peaks, falling by an average of 0.5-0.6% at the end of session.
The market appears to be struggling to choose a direction after the recent rally. Traders are evaluating various positive and negative factors. On the one hand, strong corporate reports serve as a supporting factor. However, the ongoing coronavirus outbreak all around the world weighs on the market as it is forcing some countries to introduce new restrictions.
Investors are also assessing whether the US central bank will delay its plan to roll back the monetary stimulus program amid signs of a possible slowdown in the US economic recovery.
According to BNP Paribas Asset Management, the market is in a wait-and-see mode because the moment when it can get precise information about the rollback of the QE program is getting closer.
Taking advantage of a lower risk sentiment, the greenback climbed by almost 0.3% against its main competitors, including the euro.
The US dollar index managed to rebound from the local low of 92.80 thanks to the positive data from the United States.
In the second estimate for the second quarter of 2021, US GDP increased by 6.6%, up from the previous estimate of 6.5%. And although the reading did not reach the projected 6.7%, the very fact of the revision played into the hands of the dollar.
The number of initial jobless claims in the US increased by 4,000 to 353,000 for the week that ended on August 21. However, the average four-week figure, which is of more importance for the market, dropped to its lowest level since the beginning of the pandemic.
Greenback was also supported by the fact that the hawkish wing of the Federal Reserve urged the regulator to start reducing its bond purchases. The officials are sure that this supporting instrument became not only ineffective, but also harmful.
"With strong inflation and expected continued job growth, there is an opportunity to begin to dial back on asset purchases," Esther George, the Governor of the Kansas City Fed Governor, said. She also noted that she prefers the process to start sooner than later.
"We probably don't need the asset purchases at this point," St. Louis Federal Reserve President James Bullard said, reiterating his call for the Fed to start cutting its $120 billion monthly bond purchase scheme and complete the program by the start of the next year.
"There is some worry that we are doing more damage than helping by continuing to buy mortgage-backed securities that hold down borrowing costs and arguably support even higher asset values," he added.
Dallas Fed President Robert Kaplan, in turn, repeated his view that the Fed should announce a plan after the September meeting to cut the QE program. According to him, the tapering should begin in October or "shortly thereafter" and end in about eight months.
All three pointed to the impact of high inflation on low- and moderate-income communities, as they continue to argue that the Fed's goal of inclusive growth means both maximum employment and price stability.
Some Fed policymakers believe that bond purchases are of little help anyway, as they aim to maintain demand but fail to remove obstacles that businesses face when trying to meet that demand. If the Fed does not start cutting back on asset purchases in the near future, this could damage the economy, which is already struggling with growing imbalances. However, the final word always remains with the head of the Federal Reserve, Jerome Powell.
On Friday, the greenback is trading with minor changes against its main competitors, holding near 93 points. Investors are looking for the long-awaited speech by the Fed chairman which will take place later today.
According to Pictet Wealth Management, markets want to know what J. Powell has to say at the annual Jackson Hole symposium. They have heard the views of the Fed's regional governors and want to hear Powell's opinion.
At this event, the Fed traditionally announces important changes in its monetary policy.
Although no big announcements are expected this time, uncertainty still remains.
It is not yet clear whether the Fed will announce a faster tightening of the monetary and launch the procedure for rolling back QE in September, or whether the regulator will turn a blind eye to the conflicting signals on the US economy, indicating its possible slowdown and unstable state.
In addition, investors want is a bigger threat for J. Powell: the Delta variant or inflation, and how the monetary policy of the central bank will look like after the pandemic is over.
It also remains an open question whether the head of the Federal Reserve will adhere to decisive or dovish rhetoric, given the uncertainty of his own position.
Many of us remember 2013 when then Fed Chairman Ben Bernanke tried to smoothly predict the coming cuts in the bond buying program. As a result, the long-term rates surged so rapidly that the regulator was ultimately forced to postpone the reduction in asset purchases.
Against this backdrop, markets tend to take the Fed's messages more seriously. If they do it again, it may be not a good turn for J. Powell, as US President Joe Biden is considering whether he should nominate Powell as the head of the Federal Reserve for another four years.
Currently, the market fears that Jerome Powell will follow the lead of the hawkish wing. This could trigger a deeper correction in US stock indices by 5% or even 10%. In this scenario, we can witness the acceleration of the uptrend in the US dollar.
A breakout above 93.73 (the high of 2021) would open the way for USDX to 94.00 and then to 94.30 (November high of 2020).
If the Fed's Chair considers Delta a more serious risk factor than inflation and takes a conservative approach, postponing the curtailment of QE, the stock market will strengthen and the US dollar will ease. In this case, the initial target for bears will be the level of 92.50.
Greenback may well reach annual lows in the area of 89.60 if Jerome Powell announces the continuation of the ultra-soft stimulus policy amid a surge in the number of COVID-19 cases and some signs of a slowdown in the US economic recovery.
However, Westpac doubts this outcome.
According to the bank's forecast, the USD decline will be limited to the area of 91.5-92.0. In the fourth quarter of 2021, the US currency may set new highs at 94.00.
Although Fed officials keep in mind the risks of the Delta strain, they are unlikely to change the schedule for QE cuts. Key Fed officials in Jackson Hole and beyond seems to be confident that further progress is yet to come and that it is time to slow down asset purchases in the coming months. FOMC meetings in November and December look good for announcing QE cuts, Westpac strategists said.
"Fresh highs on USD just above 94 will be possible in the fourth quarter, given that the Fed is still moving towards narrowing QE, and the ECB is unlikely to abandon stimulus measures anytime soon. Sustained growth above this level will require a slower economic recovery in the eurozone or further COVID-19 problems in China," they added.
"We believe that the ECB will stick to the current €1,850 billion PEPP program, which still has enough power to postpone the reduction of purchases until the first half of 2022," Nordea Bank said.
"Continued monetary support from the ECB will limit the upside potential for bond yields in the EU, and given that the Fed intends to act faster in removing monetary stimulus, we see significant downside risks for the EUR/USD pair," analysts added.
Expectations that the Fed will announce the timing for asset purchases withdrawal in Jackson Hole have eased somewhat, which put pressure on the US dollar and allowed EUR/USD to recover from a 9.5-month low.
However, DBS experts warn that the euro could weaken if market participants close their short positions on the US dollar, realizing that they have made a hasty decision.
Yesterday, the EUR/USD pair renewed its weekly high at 1.1780 but then pulled back, following the trajectory of US stock indices.
On Friday, the pair is trading in a narrow range of 1.1740-1.1770.
The next obstacle could be found at 1.1805 (mid-August high), followed by 1.1830 (55-day moving average) and 1.1906 (end-July high).
Initial support is located at 1.1725, followed by 1.1695 and 1.1660.
