LIVE MARKETS-Fed steepening and what it could mean for the direction of the dollar

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FED STEEPENING AND WHAT IT COULD MEAN FOR THE DIRECTION OF THE DOLLAR

The market reaction so far this month to a myriad of headlines on the Fed and trade has been relatively muted.

Still, Ben Emons, founder of Fed Watch Advisors, is noting that the yield curve is steeper and the dollar is weaker on the Trump Administration's push to remove Fed Governor Lisa Cook from the Fed Board.

As Emons sees it, with Fed Governor Adriana Kugler's step down, along with what he thinks will be Council of Economic Advisers Chairman and Trump Fed Board nominee, Stephen Miran's unlikely Senate confirmation, it leaves two open FOMC permanent voter seats vacant for the September meeting.

"In the 2010s and 2020s, the Fed Board had extensive periods of open seats, which reduced the number of permanent votes and provided more influence on the regional Fed presidents on policy," writes Emons in a note.

He adds that, in the current situation, the regional members of the FOMC, Jeffrey Schmid and Alberto Musalem, are not in favor of rate cuts, and alternate regional members, Lorie Logan and Beth Hammack, have pushed back as well.

Thus, Emons believes the September meeting will be live, but a close call with, potentially, more dissenters against rate cuts this time around. With this, he thinks the yield curve could materially steepen and drive the dollar weaker, as this trend intensifies.

Here is a rough recreation of Emons' chart showing the 2-year/30-year yield spread and the Dollar Index =USD (scale inverted).

On the other hand, from a macro perspective, Emons believes the Fed may turn even more dovish by replacing Kugler and Cook with new members who back lower for longer.

In his view, such a policy stance could spark growth with upside inflation, which could shift rate expectations further out.

In fact, he says the forward Treasury and TIPS curves are displaying this outcome. And by assuming a low neutral rate (0.5%), Emons says the Taylor rule points to a sub-3% funds rate. At the same time, he says long-dated forward rates are nearly 6%.

Emons believes that in the event the Fed moves to lower for longer, the yield curve could become "super steep," which may drive the dollar down toward its pre-pandemic lows (85-90 range).

(Terence Gabriel)

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