Will Powell shrug at Jackson Hole?

John Hardy

Head of FX Strategy

The market is trying to a put a positive spin on risk sentiment, placing the Turkish situation in the “contained for now” category with some looking around for emerging market bargains and others piling back into can’t-stay-down US equities yesterday. 

Chinese investors meanwhile, continue to stream for the exits as the Chinese market posted a fresh decline to a new low close for the cycle. 

In FX, the JPY crosses saw a half-hearted bounce while EM currencies were generally bid. The action looks nervous and lacking in conviction, and the case of bad nerves may continue until next Friday’s speech from Federal Reserve chair Powell on “Monetary Policy in a Changing Economy” at the Fed’s Jackson Hole conference. 

Arguably, the narrative is that global markets will remain in a fragile state until the Fed backs off its quantitative tightening and rate hiking regime, with the risk of a real crisis linked to EMs' overindulgence in borrowing in USD over the past near-decade since the global financial crisis. 

Estimates suggest EM countries hold some $9-11 trillion of debt in USD, and there could be more USD exposure than that linked to swap arrangements. 

At some point, the narrative dictates, the Fed will simply have to blink and exercise the "Fed put" to bail out global financial markets and avoid the risk of an EM crisis that devolves into a full-on, new global financial crisis, eventually feeding back into the US economy. The chief counter to this argument is twofold: first that Powell has stated as recently as May that he believes EMs are well equipped to deal with the Fed’s policy tightening and second, that he is dealing with a heavily stimulated domestic economy with core inflation reaching its highest levels in July since 2009.

Powell has sent all manner of signals that he sees the US economy as strong and in need of further gradual tightening via rate hikes. The market is meeting the Fed’s policy forecasts about halfway, pricing in the September Fed hike as a sure thing, December as only likely, and then openly questioning whether the Fed ever makes it to a 3% policy rate over the next 18 months.

So, those fearing that Turkey is merely the first victim of a rolling global credit crunch would argue that Powell is Atlas holding up the sky (the world-crushing sky of debt, too much of it denominated in US dollars). If he shrugs – and Jackson Hole may be soon enough for the market to react to the Fed’s signaling on whether it will shrug for now – we risk a further aggravation of recent developments. 

It is hard to measure how intense the speculation is around Powell’s speech, but the narrative I describe is at least partially in play. In short, anticipation of the Fed’s stance is taking on a new urgency that is directly linked to the latest blow-up in EM volatility and the direction of the US dollar is the world’s chief driver.

Chart: AUDUSD 

The bounce in AUDUSD looks half-hearted at best and a number of recent developments could continue to weigh on the Aussie here. The most prominent of these is the concern that China is on course for a hard landing, with the most immediate coincident indicator the yuan and whether Chinese authorities allow USDCNY to head above 7.00 (with Saxo Head of Commodity Strategy Ole Hansen arguing that China will keep the floor under the yuan at least until US-China trade talks later this month). 

As well, the recent plunge in copper prices and iron ore surrendering a large portion of recent gains are additional negatives. But the direction of the US dollar is another driver and Powell’s upcoming speech will be the “decider” on direction for the medium term. For now, the action is bearish as long as AUDUSD remains below the 0.7300-50 pivot area.

Enlarge
Source: Saxo Bank
The G-10 rundown

USD – the US dollar is the risk-on/risk-off driver at the moment with next Friday’s Jackson Hole speech from Fed’s Powell the key event risk on the horizon.

EUR – Italian yields benign for the moment, as is the USD, allowing euro pairs to bounce, but how do we return to normalcy any time soon here – the populist agenda is completely at odds with ECB purchases ending and EU rules. Meanwhile, the Turkish risk is possibly only contained for the moment.

JPY – the yen crosses are bouncing with the marginal improvement in risk appetite but a look at Chinese equities suggests little cause for celebration.

GBP – sterling drops against the euro whenever the latter sees a bit of relief. Absurdly strong UK Retail Sales likely linked to a hot, sunny summer, but don’t trigger a reaction – it’s all about deal/no-deal Brexit and the concern that the risk of the latter is rising.

CHF – doesn’t take much relief from Turkey and Italian yields to see a relief rally in EURCHF, but headline risks can return at any time and we see the potential for 1.1000 on fresh existential strains linked to Italy or additional negative headlines out of Turkey.

AUD – a modest relief rally in the Aussie, as we discuss above, but Chinese markets and key metal prices are an immediate source of concern.

CAD – CPI up today looks like a tactically important event risk for whether USDCAD spills higher and oil prices are also perched near big downside pivot levels – so potential for considerable tactical volatility here.

NZD – NZD avoiding the spotlight very successfully – generally negative on the currency, but whether it can outpace the Aussie to the downside is our chief interest. Given the more dovish RBNZ we would have expected 1.1200 or higher already now, but China is a bigger distraction for AUD at the moment.

SEK – SEK likely sidelined ahead of Swedish elections, but not too early to consider EURSEK downside strategies.

NOK – Norges Bank said yesterday that everything has developed as expected and given the previous tip-off that it will hike rates in September, that’s what we should expect. Given NOK edging weaker, looks like the market focusing on weak oil market and expecting a very dovish hike in September.

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