Dollar firms on hawkish Warsh at Jackson Hole, heads for weekly gain of nearly 1%

The U.S. dollar on Friday hit a near two-week high after Federal Reserve Chair Kevin Warsh’s first keynote address at the Jackson Hole conference was perceived as hawkish. Traders added to their expectations of a central bank rate hike in September after Warsh said underlying inflation trends had not "meaningfully improved." 

The greenback was also set for a weekly rise of about 1%, wiping out all the losses from the previous week that was sparked by the so-called debasement trade amid a steep sell-off in U.S. Treasury bonds.

At 15:36 ET (19:36 GMT), the U.S. dollar index, which tracks the world’s premier currency against a basket of six major peers, climbed 0.5% to 99.65, its highest level since August 18. 

September rate hike back in play after Warsh’s speech

The Fed’s chief’s much-awaited keynote address at the annual Jackson Hole Economic Policy Symposium saw him touch upon topics ranging from artificial intelligence to forward guidance to a summary of current economic conditions. Notably, he said underlying inflation trends in the U.S. had not "meaningfully improved" and reasserted that the central bank’s focus should be on delivering price stability.

Warsh’s speech came at a complicated time for the Fed. Sticky inflation data recently, elevated oil prices amid a seemingly never-ending conflict between the U.S. and Iran, and a surprisingly weak read on nonfarm payrolls have led to ructions in the Federal Open Market Committee (FOMC), with three regional presidents dissenting with July’s move to hold interest rates steady.

"As of now, I believe the labor markets are consistent with full employment. But on the price-stability side of our mandate, the numbers are more concerning," Warsh said in prepared remarks.

The keynote address was perceived as hawkish, with traders raising their expectations for a quarter-point hike by the FOMC in September. As per the CME FedWatch tool, the odds of such a hike now stood at more than 57%, up from about 35% the previous day.

"Chair Warsh’s Jackson Hole address surprised us in its specificity about the economy and outlook and with its lean in a decidedly hawkish direction. Following his comments, we believe the burden is on incoming data to surprise meaningfully to the downside to avoid a 25bp rate hike in September. In turn, we continue to believe the Fed will hike 50bps this year, with increases at the September and December meetings," Deutsche Bank analysts led by Matthew Luzzetti said. 

Dollar recovers after debasement trade 

Meanwhile, U.S. Treasury yields turned higher after Warsh’s speech, as bonds were dumped. The benchmark 10-year yield was last up 5.9 basis points to 4.729%, while the more rate-sensitive 2-year yield climbed 12 basis points to 4.352%. The bond market has been on a roller coaster recently, with longer-term maturities gripped in a sell-off driven by inflation jitters, corporate debt issuance concerns, and worries over the ballooning U.S. national debt.

A surprise intervention move by the Treasury Department last week has had little effect to cap yields.

Generally, climbing bond yields act like interest rate hikes as they drive up borrowing costs for consumers and businesses, which in turn tends to strengthen the dollar. But news that U.S. debt had crossed $40 trillion caused fiscal skepticism last week, and in such an environment investors looked to move capital out of fiat currencies and into hard assets such as gold or cryptocurrency - a strategy known as the debasement trade.

Indeed, the U.S. dollar index shed nearly 1% last week, while gold and crypto rallied. The latter two had advanced this week as well, but the gains were much smaller amid the strengthening dollar. 

Loonie heads for steep weekly loss amid trade war 

Turning to other major currencies, the Canadian dollar grabbed the attention of foreign exchange traders this week, down 1% amid an escalating trade war between Washington and Ottawa. 

Following the collapse of negotiations between the two last weekend, both sides have levied tit-for-tat tariffs against each other. President Donald Trump on Thursday moved to rename Lake Ontario to Lake America. 

Canadian government data on Friday showed the North American nation’s economy rebounded sharply in the second quarter, expanding at an annualized rate of 3.3% and picking up significantly from the first quarter’s upwardly revised growth of 0.3%. The increase was in-line with economists’ expectations but was well above the Bank of Canada’s forecast of around 2.5%.

"While the near-term outlook remains uncertain due to the recent trade war escalation with the United States, we suspect Canada’s economy to remain resilient despite this. Fiscal intervention is an important offset to any direct trade war headwinds. Moreover, we are upbeat on cyclical and structural growth drivers," David Doyle, head of economics at Macquarie, said.