Powell expected to give dovish testimony reflecting recent FOMC minutes

Potential Trump win could raise US yields due to inflation concerns

by Faruk Imamovic
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Powell expected to give dovish testimony reflecting recent FOMC minutes
© Getty Images/Alex Wong

Main Points

Traders are willing to push US equity index futures higher this morning, perhaps because they anticipate a "dovish" tone from Jay Powell's testimony today (see below).

This could help eke out a few basis points of gains, before volatility of the US earnings reporting season sets in by next week. It's been less enthusiastic for Europe's indexes, however. They fell late in the session yesterday, after an initial rally, and continue to languish this morning.

Poorer stock market performance from Europe is a testament to the new uncertainty emitting from the National Assembly election in France, and the adverse implications it could have for deficits (see sidebar Figure) and growth.

Of course, Europe's growth has already lagged that of the US since the pre-pandemic baseline (i.e., over the past five years - see sidebar) for familiar internal reasons: (1) adverse demographics, (2) fragmentation of financial markets along national lines, (3) lack of high-tech innovation, and (4) market frictions in the labor market.

The past two years have also had external problems: (1) the decoupling from Russia's energy supplies, and (2) China's overcapacity and lack of demand for imported capital goods, both exacerbated by China's high subsidies for its manufacturing industries.

But now, with the election in France bringing into sharper relief the popularity of the populist right and the far left - traders can look forward to higher taxes, higher spending, and less fiscal responsibility, overall.

That's not a formula for better growth in France, of course, but on top of that, traders also suspect that Europe's debt crisis management institutions - e.g., the European Stability Mechanism, (ESM) and the ECB's Outright Monetary Transactions (OMT) are less likely to come to France's rescue if there's a
funding problem that stems from the Left's policies while the Left holds power.

It is believed that lingering uncertainty about France's fiscal path, general apathy around the prospect for Euro area growth, and lingering doubts about the political cohesiveness of the EU polity, both within EU countries and across EU countries, will continue.

It's hard to see the EUR/USD staying sustainably above 1.08 in the medium term with these worries in mind, unless it is kept there by a general weakening of the USD. But a general weakening of the USD would only happen if the US economy slips downward much more precipitously than the rest of the world's, which causes the Fed to ease by more than the other major central banks in 2024.

Right now, however, it seems as if the whole world is in a growth funk in recent months. It is expected that Jay Powell, in his testimony to the Senate's Banking Committee today, is going to highlight the slowing conditions in the US.

Powell will use the Congressional testimony to give the Fed's institutional view of the economy and policy, rather than his own. (His remarks use "we" and "the Committee" when discussing decisions and outlooks, and he refers to the testimony as the Federal Reserve's Semiannual Monetary Policy Report, to be sure.) And since Powell sits on the more dovish side of the spectrum of Fed officials, his testimony might not sound as "dovish" as he would otherwise have sounded if he delivered his views.

Yet, from last week's FOMC Minutes, there's a lot of new evidence that suggests that Fed officials are increasingly focused on the downside trends in demand in Q2, as well as on the loosening of the US labor market. So a 'dovish' tone is expected to also shine through in Powell's testimony today.

Traders should look keenly for any hint that the Fed may begin to ease in September, which would be early enough to allow two rate cuts in 2024.

Federal Reserve Chair Jerome Powell© Getty Images/Samuel Corum

If Powell is dovish, it could take the USD lower temporarily, and USD/JPY is considered particularly vulnerable to a shift in sentiment if Powell is 'dovish' so long as the pair remains above 160.

Based on CFTC positions of traders reports, speculative short JPY positioning remains at extremely high levels. And yet, Powell may not be the only event that sways the USD today. What happens with the US presidential election matters too, to some degree.

In that regard, stories emerged in the mainstream press yesterday that suggested that President Joe Biden was on his way to securing support for his candidacy from key congresspersons, including Senate Majority Leader Chuck Schumer.

(So far, no Senator has publicly called for Biden to leave the race, but at least half a dozen House members have done so, separately) But this morning, ABC News reported (here) that House Democrats and Senate Democrats will meet behind closed doors today to discuss Biden's candidacy collectively.

This would be the first meeting of congresspeople for this purpose.
Yet it's not clear how a collective call to abandon his candidacy from Congresspersons would cause a change in Biden's decision to stay in the race; only the cabinet can remove the president from office for incapacitation (under Article 25 of the Constitution).

However, if communal calls for Biden to step down do emerge from Congress, and if this increases the prospect that Donald Trump will win the election because it sways the electorate's views on Biden's condition, it is thought that it would cause US yields to rise, as happened after the June 27 debate.

That could give spur to USD strength, again. According to some views (here) - and for reasons about tariff policy, tax policy, and immigration policy - traders will associate Donald Trump's (2.0) policy agenda with more inflation than Biden's (2.0) policy agenda.

The premise is that the Fed would keep policy rates "higher for longer" under a new Trump administration than under a new Biden administration.

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