Powell Preview: Unleashing the hawks or downing the Dollar?

Which kind of continuity? 

Fed Chair Jerome Powell entered officed early in February and now faces his first major event, a testimony on Capitol Hill. The Fed releases Powell's statement on February 27th at 13:30. He will then read it out at around 15:00 and then face a Q&A session with lawmakers. Another Q&A session is due on March 1st, but the first event is set to be the primary market mover.

The importance of this event not only stems from it being the first of its kind but also as markets do not know too much about Powell's views. As a Fed Governor from 2012, he always voted with the majority and never dissented. In addition, he also made very few public statements about monetary policy, maintaining high uncertainty. In his confirmation hearings, Powell sent a message of continuity.

Since he was sworn in, we learned that wages are rising at a more rapid clip and so is inflation. 

What does continuity mean?

There are the two main scenarios. Powell is making his first testimony and therefore may provide straight answers, different than his predecessors. 

However, Fed officials often refrain from giving a direct answer and only provide subtle hints or just dodge the questions with long and meaningless answers. It is safe to assume that Powell received some professional training for this appearance to slip something that would rock the markets too much.

The Powell Put Scenario

Does continuity mean sticking to three rate hikes in 2018? That was outlined in the dot-plot in the December 2017 meeting and also beforehand. While the composition of the Fed has slightly changed, holding onto three hikes would represent continuity.

If he does not convey a straightforward message, markets will assess the emphasis of his words. If he leans towards caution, waiting to see more data on wages, waiting to see the impact of the recent tax cuts and fiscal stimulus, etc. his message will be perceived as dovish.

In this case, the markets would breathe a sigh of relief on such a "Powell Put." Markets would receive support from the Fed and not for the first time in history. The US Dollar would drop, and stock markets would rally on a looser path of monetary policy. Currencies that are trending higher may benefit more than others. These would be the Euro or the Aussie, could benefit more than others.

The "Jerome Jitters" Scenario

But continuity could also mean sticking to being data-dependent. Being data-dependent is a message often heard from the Fed, that wants to see the economic developments before acting. As wages and inflation have risen, a reaction to this data would imply accelerating the path of rate hikes and raising rates maybe four times instead of three. 

How could a hawkish message look like? If he is optimistic about the economy, sees further growth and is encouraged by wage and price development, markets may begin pricing in four hikes in 2018.

In this case, stocks would tumble on the hawkish message, and the US Dollar would rise. Currencies that are already vulnerable would suffer more than others. These would include the British Pound and the Canadian Dollar. 

Conclusion

The testimony by Fed Chair Powell is closely watched. Markets want clues about rates in 2018 and to know Powell's stance throughout his tenure. Pricing in a hawkish Fed Chair is very different than pricing a dovish one. Every word will be scrutinized, and a slip of the tongue is not unthinkable in his first such appearance. 

The US Dollar may experience significant volatility at the release of the statement, the testimony, and the two Q&A sessions.