No silver bullet for doves

Speaker A: Um, hello and welcome to the Currency Exchange NatWest Markets FX podcast where we break down the major themes and events driving currency markets this week and in the week ahead. Today I'm joined by Brian Dangerfield who is our US head of G10FX strategy. And it was quite a week in financial markets. We had the long awaited first meeting of new Fed chair Warsh. There were many different component parts to this meeting with the updated dot plot and economic projections as well as the press conference conference to digest. Brian, I'm very intrigued to see what your takeaways were from this meeting.

Speaker B: Yeah, thanks very much for having me, Emir. So, you know, this meeting was quite hawkish in terms of certainly the market's interpretation. And it really came down to the message coming from the majority of the committee in the dot plot, you know, as part of the summary of economic projection. So, you know, in the build up to this meeting, and we discussed this, we discussed this in the podcast last week, we felt that this meeting was really going to come down to two competing factors because as you mentioned, Kevin Warsh, this is his first meeting at the FOMC as the new chair. And we believe, and I think there's evidence of this from the press conference, that Warsh's view on appropriate policy is on the dovish side of the committee. But this is also the first meeting that we get the new projections since March. And over that time, uh, economic data have generally been stronger than expected. The labor market has shown signs of stabilization and maybe even some signs of reacceleration. Economic data broadly in the US have been stronger. And even though oil prices have come back down, reflecting the recently completed U.S. iran deal, um, FOMC officials, the rank and file FOMC officials are clearly a bit more cautious about the upside risks to inflation, the more persistent risk to inflation that are maybe fueled by a stronger cyclical growth outlook. And so we felt that there would be two competing forces in this meeting. One would be the dot plot where we expected a hawkish evolution and then wash on the other side of that, maybe downplaying the dot plot, saying we shouldn't be giving this type of forward guidance and maybe expressing some dovish ness and expectation that maybe even though growth is stronger, that doesn't necessarily require a more hawkish policy path because that growth is fueled by productivity and inflation. Upside is fueled by exogenous shocks, things like higher oil prices and tariffs, which are fundamentally out of the control of the Federal Reserve. So we felt there was going to be a bit of a counter play between the hawkish message and the dovish message from war. On both sides of that message, I think the outcome was more hawkish than certainly I expected. On the dot plot, just to give context, we penciled in three FOMC officials thinking that a rate hike in 2026 would be appropriate. Instead, it was nine FOMC officials that had at least one rate hike in their projection for 2026. So that alone was quite a bit larger. There are 19 participants on the FOMC, 18 of which put down dots for 2026. So of the people who decided to submit forecast, Warsh notably abstained. Half of those officials believed that the future path of policy in 2026 for the second half of the year, uh, should be higher rates rather than unchanged or lower. Additionally, among the members who submitted forecasts that included hikes, six of them actually had more than one hike. So either two or even three hikes. Six of the nine members who thought that the policy rate should be higher by the end of the year thought there should be more than one interest rate hike. So the message there from those members of the committee is very clear that rather than simply seeing one interest rate hike as a, like an insurance move against higher oil prices, for example, that those officials who believe it's time to tighten believe that it should be multiple moves rather than simply one move. So more of a mid cycle adjustment back in the hawkish direction rather than a one off interest rate increase. So the dot plot was notably more hawkish than we, and I think everyone in the market expected. It was clear that some officials have been starting to discuss the possibility of hikes. This threw the door open to multiple members of the committee. A significant portion of the committee believing that hikes should now be the baseline. So that was quite hawkish. But as I mentioned, there was an exact even split between nine participants who believed that hiking was appropriate and nine who either saw unchanged rates or lower rates this year. So it was exactly even between the members of the committee that do not include Governor Warsh, uh, Chair Warsh, who is now the president of the committee, the leader of the committee. So you can effectively think of a tiebreaker vote being Warsh. And Warsh, on balance, I think is probably on the dovish side. So if you think about, you know, the committee being split between hiking and not, and you end up with Warsh as sort of the quote unquote tiebreaker, then that tiebreaker vote probably goes towards unchanged rates or even towards maybe lower rates if Warsh were to have his way. So the dot plot was Quite a bit more hawkish than expected. Against that, Warsh had an opportunity to downplay the dot plot median. Instead he took a more sort of passive approach. He kind of stepped back a little bit and said, this is what the committee decided to pencil down. I myself Wash did not participate in that exercise. He did say that the committee made those projections, quote unquote in pencil. This idea that there needs to be some humility about if that's an appropriate path or simply an expectation based on current conditions. But he really didn't give the market that sort of silver bullet of dovishness that I think might have been expected in the past. There have been times when the Fed chair has come out in the press conference and said, hey, the dot medians moved. But don't take that as a policy prescription. Take my message as a policy prescription, either emphasizing the dot plot at times or maybe pushing back against the dot plot at times as maybe the core signal from the committee. Warsh didn't really opt to do that. I think there were signs of dovish ness within Warsh's press conference, but it was subtle signs of dovish ness. It wasn't that overt, as I mentioned, that sort of silver bullet of dovishness that Warsh comes out and says, hey, the committee might be more hawkish, but the reality is that the core committee that I am leading is probably not going to end up with more hawkish policy. And so I considered Warshaw's press conference really hawkish by omission. That, uh, he himself I don't think was particularly hawkish. But I think by not giving that, that moment of pushback, that obvious moment of pushback, by just basically saying forward guidance is useless in this environment. So I'm not going to tell you anything that was hawkish by omission. And so we had a pretty material reaction in the dollar. And I think the market's interpretation of all of this. There has been a clear shift in the center of the committee towards thinking that hikes, uh, are not only something that should be on the table, but that might be appropriate or required. As a result, we've seen a pretty meaningful uptick in expectations for the possibility of rate hikes this year as soon as even the next meeting is possibly live for a move. And Warsh, while my personal opinion, and I think you can hear this from the press conference, is that he would be reluctant to deliver a rate hike both in the near term and over the next several meetings still, uh, but by not actively pushing back against that, he didn't do much to maybe micromanage the market away from that conclusion. And so it was quite a hawkish meeting, all, ah, things considered, certainly well above and beyond what I thought was a high hawkish bar for this meeting to hurdle.

Speaker A: I think what you say, hawkish by omission is such a great way to put it because I think going into it, markets have set very high expectations in terms of how dovish worse was going to be. And um, and I guess wrapping this all up kind of what is the implication for the US dollar and does it change your dollar outlook?

Speaker B: So it does. Well, I think where it really impacts the dollar outlook is that, you know, it will be certainly a lot harder for the committee to come around to the idea of rate cuts certainly in 2026 in the near term. And so our economists actually pushed out their expectations. Uh, we no longer have a rate cut this year in our House projection. So that has pretty clear, potentially positive implications for the doll relative interest rate perspective that if the Fed is not delivering on those rate cuts, then you're not going to get that interest rate convergence that tends to lean against your currency. So that's a pretty obvious first order implication. But to the same extent, we do think the market is still overpricing the risk of rate hikes from the Fed because while the center of the committee has moved its most important vote, we do not think is currently going to support increasing interest rates. And that would be, of course, Kevin Warship. And so the question of who is ultimately the most responsible for Fed policy, is it the majority of the committee, which is being largely driven by, I think, the regional presidents who have generally been, I think, on the more hawkish side versus the the chair of the committee who is selected by the President, confirmed by the Senate, who ultimately controls the messaging. I think the market is trying to figure this out in real time. Is, is there an opportunity for, say, Warsh to be outvoted by the committee if the committee wants to favor a rate hike in say, the next several meetings? We just don't know that answer. We don't really know yet if Warsh's view will ultimately be the one that drives the day, or will the set, call it the tyranny of the majority kind of takes over and allows the Fed to pivot a lot more hawkish than even Warsh's own base case. Whether a consensus view or the view coming from the top is ultimately the one, um, that wins out. Another thing is that Warsh's main message was let's just watch the data and the reality is that the data have been broadly strong. And so it's understandable that the market's base case has certainly improved both from the dollar side and from expectations for Fed policy. Now that's just an appropriate response to how the data have evolved both on the uh, on the cyclical growth side as well as uh, on the inflation side. And so we still think that the Fed probably does not end up delivering on tightening expectations that the market has priced in at the moment. But equally we sort of need the data to reinforce that view if we're going to see a weaker dollar from here. So clearly the risk to that outlook is that if the data end up staying strong, if the cyclical data, particularly on the labor market, continue to outperform, the ability for the dollar to weaken even in a positive risk scenario where oil prices have fallen back lower, is just going to be a lot less. And so still feel like there is a path here for the dollar to weaken over the next coming months. If we're right that the market is pric Fed tightening, but to that same tone, it would be harder for the dollar to weaken a lot if the Fed is no longer expected to deliver cuts, which normally is consistent with interest rate convergence. Um, so a really interesting outlook here where we have a potentially very positive risk picture coming from how oil prices have evolved recently. Um, certainly the big drop in oil prices and the expectation for a potential reopening of the Strait of Hormuz with the new US Iran deal, maybe seeing some positive risk feed through certainly into your world emir and some of the higher carry ems, whether or not those currencies could be supported in a better risk environment. But that's sort of been counterbalanced by this more hawkish Fed and how the stronger cyclical data have been supportive of the dollar. And so we have two, I would say, almost competing narratives in the dollar right now. That makes it a really interesting time to be, uh, to be analyzing these markets.

Speaker A: Yeah, I would certainly echo that. I think for emerging market currencies, you had that relief rally coming from this memorand standing over Iran. But then you have the prospect of perhaps a more hawkish Fed than the market was expecting. And obviously kind of higher U.S. yields and a higher dollar is only going to compound local currency weakness. But as you say, we think actually the former wins out, that it is a more positive global environment and it should be supportive for global risk assets. But the Fed was not the only central bank you had to contend with this week. We also had the bank of Japan that finally raised interest rate at 25 basis points to 1%. And it's definitely telling that that is a 31 year high for interest rates in Japan. I guess what were your main takeaways from that meeting?

Speaker B: I think compared to the Fed, which offered very little forward guidance going into this decision, and as a result left the market really ruffled a lot of feathers in the market, caused a large market reaction with a surprising move in terms of its guidance coming from the dot plot. The bank of Japan was the polar opposite, where the interest rate hike that they delivered at the June meeting to the uh, 25 basis point rate hike was fully pre signaled. It was effectively leaked through various media, media sources. It has been built up over a period of several months. And I think about the rate hike delivered in June as effectively delayed response to what would have normally been strong argument for a rate hike all the way back in March that was delayed because of the US Iran war. So US Iran war starts at the end of February and into early March. And the bank of Japan stepped back from what we think would have been a pretty good case for hiking the policy rate because of understandable risks to energy markets and risks to growth and risks that come from loss of energy supplies. And so the bank of Japan stepped back, opted not to hike at its March and April meetings. This feels like the June hike delivered feels like a delayed realization of that March rate hike that had been expected before the war. And so this feels to me less like a proactive step and more like a delayed response to conditions that I think domestically had have justified interest rate tightening, whether it come from wage growth, um, you know, continued wage growth and labor shortages sort of pushing higher wages in Japan, price pressures, potentially price pressures that could come from a more expansive fiscal stance, uh, and the like. And so unlike the Fed, which was a big surprise, the bank of Japan was very well pre signaled and as a result market moves were very muted. That's not to say that this meeting wasn't interesting though. One of the unfortunate wrinkles of this meeting was that the Governor of the bank of Japan, Ueda, uh, is unfortunately hospitalized. Uh, he has a, uh, medical issue and was unable to attend the meeting. And we wish the governor well. And this m. But for monetary policy and for market purposes, one of the wrinkles of this meeting that resulted from this unfortunate circumstance was that the press conference was delivered by Deputy Governor Uchida rather than the governor. And one of the potential consequences there that we both expected and I feel like, you know, actually happened, is that without the leader of the institution there to deliver the message. There was maybe a bit of a deference to not trying to rock the boat all that much in terms of guidance that Uchida, maybe relative to what UEDA could have been, was maybe less willing to signal to the market something dramatically different than what we've been hearing from the bank of Japan for, for quite a while. And so all of that kind of, you know, in combination the decision being pre signaled and coming right in line with what the market expected, uh, the press conference not really delivering a lot of big change in guidance and message, maybe that being influenced by the fact that Governor Uedo was not the one who delivered the message. But all told, the market reaction both in JGBs government bonds and in the yen was quite muted. And I think honestly, you know, given the recent track record, you could call that a success in terms of delivering a message that doesn't necessarily really uh, rattle the market. But for the, for the, for the yen, which we'll discuss in a second, you know, uh, there's obvious important implications that a lack of change in message is still important.

Speaker A: I think that's a really good explanation of perhaps why there wasn't more forward guidance. I mean no one wants to kind of um, pre step their boss or preempt their policy guidance. So it's an interesting way to look at it. And I guess, you know, on that note, looking at the Japanese yen, I mean what are the FX intervention risks at this point in time? I feel like all the traders are kind of on tenderhooks wondering if we're going to get intervention.

Speaker B: Yeah, I think that's really important here because we have had experiences throughout the post pandemic period and in the very recent past where MOF intervention, buying the Japanese yen, those activities have come in response to event risk, specifically FOMC and Bank of Japan related event risk. So as recently as late April and early May, the market's response to a hawkish Fed and the bank of Japan holding off on interest rate hike at the time was a higher exchange rate, you know, a more hawkish Fed, a more dovish boj, interest rate divergence that tends to move your currency weaker. And the MOF came in and intervened to effectively enforce a stronger yen, even though the market believed that the fundamentals coming from the two messages coming from the two central banks pushed the other way. So this is another opportunity where the Fed was more hawkish and the bank of Japan was, you know, the, an interest rate hike was delivered and the currency did not materially weaken or strengthen. But on balance, dollar yen is still higher and sort of probing into testing levels that we haven't seen uh, in several decades. You know those, those higher levels of dollar yen are not that far on the horizon here. And so I think the market is very much on alert for potential intervention here. And event driven interventions have happened back in April as I mentioned of this year. MOF has come in in response to BoJ, uh, Fed decisions that also happened over several periods in 2022 and 2024, specifically around BOJ decisions. And so there was understandable event risk already. And with Dalian now higher through these two, um, I think that risk is still very much there. One thing to add, maybe a wrinkle on this which maybe pushes back against the idea of intervention is that the dollar is broadly higher against global currencies, but the yen is actually a relative outperformer in the aftermath of this, in this dollar rally. So for example yen relative to the euro and relative to some of the risk sensitive Currencies in the G10, the Yen is actually stronger. It's been one of the relative outperformers. Part of that is probably somewhat related, linked into the risk reaction that as rates move higher, uh, equities yesterday in the US were quite a bit lower. And so that might be part of the story there. Also the threat of intervention might be working here as in the market is seeing pushing the dollar stronger because of the Fed's message and because of the evolution of the data. But that speculators are worried about adding to yen shorts here because of the looming threat of interventions. And so it's possible that's something that's keeping the yen from weakening even more in a stronger dollar environment. And so, so you could argue that if the dollar is rising against everything, then the yen is not weakening for fundamentally misaligned reasons, that this isn't out of line with fundamentals if the dollar is stronger against everything, and so the argument for intervention maybe isn't there. So all of this is to say that I feel like the market should still be on high alert for potential intervention. There are reasons why this is the type of period where the MOF might consider intervening. There are reasons why this move in the yen is something that is not necessarily specific to the yen. It's not necessarily a sign that speculators are piling into to yen shorts. One last thing I'll mention here is on fiscal policy that as we're thinking about the BOJ on the monetary policy side, on the fiscal policy Side, we think the Takaichi government is still pivoting towards a fairly expansionary fiscal stance. In addition to supplemental budget that was intended to support the, uh, economy through a period of energy disruption, there's also continuing discussions ongoing about cutting the consumption tax on food and beverages. We're expecting to get more information on that as we go through the summer. But maybe the broader point is that fiscal policy is still likely shaping up to be pursuing a high growth, um, high stimulus posture. And with that very stimulative fiscal policy, monetary policy is still relatively stimulative, uh, both in real terms and also in relative terms. So the BOJ policy rate at 1% is still well below most of its peers in major economies. And so for the yen, I think you still have a fiscal monetary mix that is quite stimulative and that tends to be a negative for the currency. And so that's also a consideration here. Certainly the upside risk in dollar yen is maybe limited because the market is very wary of that intervention risk. But on the other side of that coin is you have a domestic policy mix in Japan that I think is still sort of skewed towards fundamental weakness in the currency rather than necessarily strength. So, uh, we'll certainly be watching, uh, for potential action from mof. But, you know, there is still the fundamental picture for yen, I think, still has challenges within it that come from this very stimulative fiscal and monetary mix.

Speaker A: Yeah, it's true. I mean, how long can m the threat of intervention really kind of support or underpin the yen? That's probably all we have time for this week. Brian, thank you so much for joining us and for sharing your your thoughts. As always. If you did like the podcast, please do remember to subscribe and to click like so you can get the latest episode first. Thanks again.