Powell signals it’s time to cut; dollar sinks but risk rally muted

Powell green lights rate cuts 

Fed Chair Jerome Powell locked in a September rate cut on Friday, using his Jackson Hole address to signal the Fed’s long-awaited pivot toward an easing cycle. Using somewhat more dovish language than anticipated, Powell said the “time has come for policy to adjust”, adding that the timing and pace of rate cuts “will depend on incoming data”.

Although that alone provides no hints to the possibility of a 50-basis-points rate cut, which is what markets had been hoping for, Powell’s emphasis on supporting the labour market and the need to prevent further cooling was unmistakable.

Equity markets underwhelmed 

Wall Street surged as Powell delivered his remarks, yet there was no runaway rally and the main indices closed slightly more than 1% higher. Small caps were the exception, with the Russell 2000 soaring by 3.2% as Treasury yields slumped.

Asian and European stocks have had a mixed start on Monday and US futures are only marginally higher. There seems to be a bit of a ‘buy the rumour, sell the fact’ effect in equity markets and although Powell has clearly shifted the Fed’s focus away from inflation to the labour market, he said little to significantly alter near-term rate cut expectations.

Small caps main winners as Nvidia earnings eyed 

On the whole, there’s still a risk that market expectations are overly dovish as investors have priced in two full percentage points of rate cuts over the next 12 months. This suggests that underperforming sectors such as small caps will be the real winners now that the Fed has actually made its pivot.

However, it’s also likely that mega caps continue to suffer from overvaluation concerns and the next leg of the rally will depend on the outcome of Nvidia’s earnings, which are due on Wednesday. If Nvidia injects some optimism with its earnings, that could fuel the rally until the September FOMC meeting when investors will get a clearer view of the projected rate path.

Pound and euro claim key levels 

Bank of England Governor Andrew Bailey, who also spoke at the Jackson Hole symposium, was somewhat more cautious than his Fed counterpart. Nevertheless, Bailey seemed to echo Powell in pointing to the fading upside risks to inflation.

But that didn’t stop the pound from being one of Friday’s best performers, surpassing the $1.32 level for the first time since March 2022. The euro also brushed fresh highs, flirting with the $1.12 handle.

Against the yen, the US dollar slipped below 144.00 and its gauge against a basket of currencies sank to a 13-month low.

The greenback's downward trajectory since mid-July appears to have been reinforced by Powell’s big speech. However, a near-term bounce back is possible this week if Friday’s PCE inflation data surprise to the upside. Eurozone CPI numbers will also be critical on Friday as the ECB’s September meeting approaches.

Oil and gold march higher 

Another big winner of the dollar’s slide is gold. The precious metal is on the verge of hitting a new all-time high today, coming close to last week’s record of $2,531.60/oz.

Oil prices are also up, but mainly due to the growing threat of a major military escalation in the Middle East as Israel and Hezbollah exchange strikes. In a further setback to peace, the latest talks for a ceasefire in Gaza ended on Sunday without any agreement.