US Dollar: Warsh boosts policy credibility – OCBC

Fed Chair Jerome Warsh’s Jackson Hole speech helped boost USD credibility, according to OCBC FX Strategist Sim Moh Siong and Christopher Wong. They noted that concerns about debasement eased, supporting the Dollar, while Gold declined and the US yield curve became flatter. The structural worries about Fed credibility had diminished, shifting the focus towards US cyclical data ahead of the September FOMC meeting.

Markets anticipated a modest tightening, although OCBC still expected no immediate rate hike. Even with recent improvements in inflation data, Warsh reiterated that inflation remained a primary concern for the Fed, which aimed to achieve its 2% PCE inflation target. The Fed emphasized that short-term interest rates were its primary policy tool for fulfilling this dual mandate.

The recent market focus on structural USD headwinds, driven by policy uncertainty and the Treasury’s surprise EUR/JPY intervention, had challenged OCBC’s modestly bullish USD view. However, Warsh’s speech reduced concerns about Fed credibility becoming a lasting drag on the USD. The FX market now priced around 15 basis points of tightening for the September FOMC meeting, up from 8 basis points before the speech.

While a September rate hike remained possible if August CPI exceeded expectations, the base case remained a hold on the Fed’s part. A resilient labor market, persistent inflation, and the Fed’s commitment to fighting inflation should maintain a hawkish policy bias and keep the USD supported. Asian FX might start the week on a softer footing after the USD rebound following Warsh’s remarks.

Although the speech didn’t commit to a September hike, it reinforced the Fed’s inflation-fighting credibility and kept the possibility of further tightening alive if inflation didn’t ease significantly. A weaker USD could be a headwind for Asian currencies, but not enough to erase their regional differences. For now, USD dips may be more restrained, with bears needing softer US data to regain conviction. Market attention will turn to incoming US labour and inflation data ahead of the September FOMC.