Average Inflation Targeting May Already Be Priced In. Dollar Downside limited

Average Inflation Targeting May Already Be Priced In. Dollar Downside limited

Zee Mac  | Aug 27, 2020 07:50

Federal Reserve chair Jerome Powell’s speech today at the Jackson hole symposium will be in sharp focus. Many investors are expecting an aggressively dovish tone from the Fed Chief, with the widely expected introduction of AIT or ‘average inflation targeting,’ which could allow the Fed to loosen its 2% inflation target, allowing them to average out incoming inflation data and thus let inflation run a marginally above 2%. My view is that unless AIT is coupled with a large increase in bond buying or asset purchases, this significant change in Fed policy may already be priced in. If that is the case then the UST yield curve could actually steepen and see the US Dollar actually strengthen like what we witnessed following the release of last weeks FOMC minutes. This view is echoed by Credit Agricole (PA:CAGR) corporate and investment bank that said in a recent note: "The 27-28 August Jackson Hole central bank symposium could further offer glimpses into the Fed's progress towards average inflation targeting and more dovish forward guidance... We also remain hopeful that a compromise will be reached in DC on a fourth fiscal stimulus package. All that could support market risk sentiment but hurt the USD sentiment. That said, with some negatives already in the price of the currency, its downside maybe limited". 

I suspect that the today’s speech may actually trigger a correction in stock markets and unwind some of the USD Short positioning. Whilst many participants view the selling the Dollar a safe bet today, I suspect that the trade is crowded and may catch a lot of traders off guard and possibly trigger a dollar short squeeze.

EUR/USD, GBP/USD and AUD/USD pairs may struggle to break above recent highs. The recent sell off in Gold from all time highs is a good case study for this view. The Euro may actually begin the correction I have been calling, in recent weeks. Whichever way the markets head, this could be the most consequential day for currency and equity markets we have seen in months.

Zee Mac

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