At 10 a.m. EST on Friday, August 23, Federal Reserve Chairman Powell made a major statement on the issue of interest rate cuts at the Jackson Hole Annual Meeting of Global Central Banks. When Powell delivered a speech at the annual meeting, he "let go of doves" and said: "The time for policy adjustment has arrived. The policy direction has been clear. The timing and pace of interest rate cuts will depend on subsequent data, changes in the outlook and the balance of risks."

Compared with previous vague statements, Powell, who has always spoken cautiously, rarely conveys such straightforward information to the market. Powell's statement is generally regarded as a clear dovish turn, providing some clarity to financial markets in the short term.

The Fed’s focus shifts

In his speech, Powell noted that "four and a half years after the COVID-19 outbreak, the worst economic distortions caused by the epidemic are receding. Inflation has fallen sharply, the labor market is no longer overheated, and conditions are now looser than before the epidemic. Supply constraints have normalized. "

Powell's words indicate that the balance of risks facing the Fed's two major tasks of "maintaining price stability" and "achieving full employment" has changed. At this stage, when inflation continues to fall back to the 2% target, the upward risk of inflation has weakened, and the downward trend of employment has Risks have increased, and maintaining stability in the labor market has become the focus of the Fed's current work.

Powell then stated that the Fed "will do its best to support a strong labor market while further achieving price stability" and made it clear that interest rate cuts are the future policy direction.

By how many points will interest rates be cut this time?

While Powell did not specify the size of the rate cuts or the path to easing, he pointed to progress on inflation and said Fed officials will closely monitor the health of the job market as a guide for policy. His words pushed U.S. Treasury yields and the dollar lower on Friday and pushed U.S. stocks higher, giving investors a green light for risk appetite.

After Powell's speech, U.S. Treasury bond prices rose and U.S. Treasury yields of all maturities fell, with the benchmark 10-year U.S. Treasury yield closing at 3.8% on the day, down 8 basis points last week. U.S. government bonds yielded 1.44% this month, according to Bloomberg indices.

However, Jack McIntyre, portfolio manager at Brandywine Global Investment Management, said: "Markets need to digest Powell's speech and remind themselves that they - and the Fed - are still dependent on data. Although Powell's tone was dovish, the data must now support it. "

"The way forward is clear," Powell said at Jackson Hole, but "the timing and pace of rate cuts will depend on incoming data, the evolving outlook and the balance of risks."

"Whether that means 25 basis points or 50 basis points is still an open question," said John Velis, currency and macro strategist at BNY Mellon.

Powell's comments mean that the monthly U.S. non-farm payrolls report, scheduled for release on September 6, will be crucial. Velis said the recent employment data came in weaker than expected and if the next set of data does the same, "then 50 basis points could happen."

With interest rates cut, carry trade will shift to USD

In a carry trade, investors borrow money at a low interest rate and then invest the money in a risky asset with a high interest rate.

A rate cut would have a negative impact on the U.S. dollar, making it a potentially attractive carry trade currency, where traders can borrow dollars to invest in higher-yielding currencies and assets. However, these trades rely on low volatility, especially in funding currencies - something that could be called into question if conflict in the Middle East escalates. Tensions in the Middle East conflict are rising as Israel attacks Hezbollah strongholds in southern Lebanon and the Iran-backed militant group begins what it says is an initial counterattack against last month's killing of its military chief. The turmoil could disrupt interest rate cut trading plans, especially in terms of demand for safe-haven assets such as U.S. Treasuries and the dollar.

Previously, global investors had been engaging in carry trades of borrowing Japanese yen to purchase high-yield currency assets until July 31, when the Bank of Japan raised interest rates for the second time this year. That triggered a surge in the yen, causing trading to collapse and sending ripple effects across global markets.

Kristjan Kasikov, global head of quantitative investor solutions at Citigroup, said in an interview: "We have seen that our sentiment on the US dollar position is starting to become more pessimistic. People speculate that the environment of interest rate cuts has fueled risk appetite."

In late trading in New York last Friday, the U.S. dollar was trading at 144.39 against the yen. The yen exchange rate rose 0.7% on the day and rose 2.2% this week. The yen was already higher ahead of Powell's speech on Friday after Bank of Japan Governor Kazuo Ueda said hours before Powell's speech that the BOJ would likely continue to raise interest rates.

Kasikov said that as the prospect of the Federal Reserve's interest rate cuts gradually becomes clearer, coupled with the impact of the difference in interest rate trends in the United States and Japan, it is currently a wiser strategy to choose the U.S. dollar as the financing currency instead of the Japanese yen.

However, Kasikov also pointed out that the expected window for global carry trades to perform well may be quite short-lived, as the upcoming U.S. presidential election may trigger another increase in market volatility. He added: "We have been concerned about FX carry trades for some time. The U.S. election and political calendar will bring more uncertainty to the market, which in turn will increase risk aversion."