The US dollar reacted enthusiastically to Kevin Warsh’s ‘hawkish’ rhetoric, strengthening against the world’s major currencies. The recent slowdown in inflation did not mislead the Fed Chair. He considers the current monetary policy to be insufficiently restrictive and maintains that the central bank still has a lot of work to do. Such rhetoric led to a rise in Treasury bond yields, put the brakes on stock indices and gave the greenback a boost.
The futures market has raised the probability of a Fed rate hike in September from 38% to 60%. CME derivatives put the probability of two federal funds rate hikes in 2026 at 49%. Prior to Kevin Warsh’s speech at Jackson Hole, the figure stood at 21%.
The escalation of the conflict in the Middle East is adding fuel to the fire of rising economic indicators. For the first time since 29 July, the US resorted to bombing Iran, to which Tehran responded with attacks on American bases in Jordan. As a result, Brent crude has risen back above $90 per barrel, heightening the risk of accelerating inflation and prompting the Federal Reserve to tighten monetary policy.
The strengthening of the US dollar enabled the ‘bulls’ on USDJPY to push the exchange rate above the critical 160 mark. It did not manage to hold that level on the first attempt. However, the fact that speculators have been building up short positions on the yen for the second week running suggests that further ones will follow this initial attempt. The pair recouped half of its losses due to currency intervention, which totalled a record $98.7 billion.
Scott Bessent was forced to explain to Congress Washington’s involvement in the coordinated intervention in the forex market. According to the Treasury Secretary, Japan is the largest holder of Treasuries, and erratic movements in the yen could destabilise financial markets and increase the cost of borrowing in the US.
Scott Bessent has no intention of telling the Bank of Japan what to do. However, the Bank must have a clear understanding of the situation. Japan has reached the end of Abenomics, which was essentially a reflationary programme. This is a clear hint at the need to raise the overnight rate at the BoJ’s next meeting in September. The futures market puts the probability of monetary policy tightening at over 80%. Without this, currency interventions make no sense.
Summary: Warsh’s hawkish Jackson Hole speech pushed Treasury yields higher and lifted the dollar, sending USDJPY above the critical 160 mark for the first time in a month. Rising oil prices on Middle East escalation add to inflation fears, while markets now price an 80%+ probability of a BoJ rate hike in September.
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