Stanley Fischer, vice chairman of the US Federal Reserve, left, and Janet Yellen, chair of the US Federal Reserve
Janet Yellen, chair of the US Federal Reserve, with vice-chairman Stanley Fischer at the Jackson Hole symposium © Bloomberg

The dollar rallied on Friday as markets reacted to US Federal Reserve comments at the Jackson Hole symposium on the prospect of a September rate rise. But, since then, it has stumbled while US government bonds, which sold off on Friday, have rallied.

How is the dollar performing?

Fed caution has kept the dollar at bay for much of the year. The index measuring the dollar against its peers began 2016 heading towards 100, but it slipped below 92 in May and for large parts of this year has been stuck in the 94-96 range.

In the run-up to the Fed’s annual symposium, the index was falling as rate expectations faded. Friday’s comments from Fed chair Janet Yellen that the case for a rate rise had “strengthened” did little to move the dollar, but when vice-chair Stanley Fischer subsequently mentioned the possibility of two rate rises before the close of the year, the index jumped towards 96.

Why isn’t the dollar getting more of a lift?

Fed communications about its strategy have been widely criticised by market participants. Based on recent history, there is scepticism that Fed words will be followed by deeds. And in the last dregs of summer holidays, there is unlikely to be much conviction in the market until we hit September.

Why are Treasuries staying so strong?

Ten-year notes are certainly robust. Prices rebounded on Monday, sending yields to their lowest in two months. That follows a sell-off on Friday that triggered a rise in yields as the market became more alive to a September rate rise possibility. Various factors are at play — yields on Japanese and eurozone bonds are very low, volumes remain light and caution is once again feeding into market behaviour, with further clarity on the Fed’s likely direction awaited from Friday’s jobs data.

Where does the market stand on a September rate rise?

Not exactly on sure ground. According to Fed Fund futures prices, market probability stands at 34 per cent. On Monday, it was 36 per cent and last Friday it rose to 40 per cent. There is more solid ground for a December rise.

What will provide the market with more conviction?

This Friday’s US non-farm payrolls data. The US economy continues to throw up a mixed story. Consumption data showed that the economy “looked in pretty good fettle”, says Roger Hallam, chief investment officer for currencies at JPMorgan Asset Management. “The flipside is inflation was soft.”

But analysts say a strong report on jobs creation for August will revive the dollar, boost market rate expectations and provide the Fed with the momentum to raise rates at its September 21 meeting. “It leaves plenty of scope for the US dollar to strengthen further in the near-term if the latest non-farm employment report is solid,” says Lee Hardman, MUFG’s currency analyst.

Mr Fischer referred to the jobs creation data as key to the Fed’s September rate deliberations, saying he was reassured by the trend. The reverse is true — a weak report will kill off market expectations and see the dollar sold off.

But will good payrolls data be enough to trigger a September rise?

The Fed has been reluctant all year to cast off its cloak of caution, worried about the knock-on effects of a stronger dollar on the US economy, so the chances are that it will err to its natural inclination of staying pat on rates.

According to Simon Derrick at BNY Mellon, the Fed will “reluctantly” raise rates this year. While Mr Fischer’s comments has altered the odds on September, “we still think that December is marginally the more likely date for a move. However, whatever the outcome, this is a dovish Fed that remains particularly sensitive to any signs of USD strength”, Mr Derrick says.

Bottom line — is the market warming to the idea of a rate rise?

It is probably warmer to the idea than previously but not by much. As Lutz Karpowitz at Commerzbank says, the dollar did move post-Jackson Hole, albeit modestly. The Fed’s credibility is returning “only slowly”.

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