Fed Speeches, Interest Rate Expectations Update

Central Bank Watch Overview:

• The July FOMC meeting is just around the corner, and given the uptick in concerns around the delta variant, the upcoming meeting may draw heightened interest
• Traders shouldn’t expect much color before July 28, however, as the Fed is officially in its communications blackout period.
• Fed fund futures are now pricing in the first rate hike in December 2022; one month ago, September 2022 was favored.

Ahead of the July FOMC Meeting

In this edition of Central Bank Watch, we’ll review the speeches made over the past week by various Federal Reserve policymakers, including the Fed Chair himself. The July FOMC meeting is just around the corner, and given the uptick in concerns around the delta variant, the upcoming meeting – typically overlooked as it falls between the June FOMC (which brings a new Statement of Economic Projections (SEP)) and the August gathering in Jackson Hole, Wyoming – may draw heightened interest.

For more information on central banks, please visit the DailyFX Central Bank Release Calendar.

After Capitol Hill

Last week, Fed Chair Jerome Powell traversed Capitol Hill to deliver his semi-annual testimony to Congress. While ceding some ground with respect to recent inflation data, the Fed Chair himself was resolute with respect to the broader narrative the Fed has constructed in recent months: inflation is by-and-large a temporary phenomenon, and the damaged labor market needs more time to health.

After some bumps following the June FOMC meeting, the narrative around what exactly normalization means has been clarified time and again: it’s not going to be quick.

July 16 – Powell (Fed Chair) acknowledged at his Congressional testimony that recent elevated price pressures constitute “a shock going through the system associated with thereopening of the economy and [the reopening has] driven inflation well above2%, and of course we’re not comfortable with that.” However, he acknowledged that this doesn’t mean tightening is necessarily imminent, saying “inflation has increased notably and will likely remain elevated in coming months before moderating.”

July 15 – Bullard (St. Louis president) said that the Fed has met goal of achieving “substantial further

progress” on both inflation and employment, noting that he believes “we are in a situation where we can taper.” However, he noted that “[The FOMC doesn’t] want to jar markets or anything – but I think it is

time to end these emergency measures.”

Traders shouldn’t expect much color before July 28, however, as the Fed is officially in its communications blackout period.

Federal Reserve Interest Rate Expectations (July 20, 2021) (Table 1)

Ahead of the July FOMC meeting, Fed funds futures are pricing in 2% chance of a25-bps rate cut at the forthcoming meeting – immaterial. Notably, however, longer-dated expectations have come down considerably. In fact, one month ago, Fed funds futures were discounting a 63% chance of a 25-bps Fed rate hike in September 2022; those odds have since fallen to 37%. Meanwhile, December 2022 is now the favored month for the first rate move, clocking in with a 68% chance.

IG Client Sentiment Index: USD/JPY Rate Forecast (July 20, 2021) (Chart 1)

USD/JPY: Retail trader data shows 47.13% of traders are net-long with the ratio of traders short to long at 1.12 to 1. The number of traders net-long is 0.65% higher than yesterday and 15.22% lower from last week, while the number of traders net-short is 5.42% higher than yesterday and 5.15% lower from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests USD/JPY prices may continue to rise.

Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger USD/JPY-bullish contrarian trading bias.

— Written by Christopher Vecchio, CFA, Senior Currency Strategist