Head of FX Strategy
Summary: All eyes on Fed Chair Powell’s speech today at the central banker powwow in Jackson Hole, Wyoming. We suspect that Powell won’t indicate an inclination to ease more than the market has already priced in, risking further USD upside. But how risk appetite behaves in the wake of whatever he has to say may be the most important for other currencies.
Trading interest
Given the “mid-cycle adjustment” positioning of the Fed’s rate move at the July 31 FOMC meeting in the FOMC minutes released this week, and given recent rhetoric from a number of Fed officials, as well as the generally positive description by Fed officials of the current state of the US economy – upped concerns on risks from trade policy notwithstanding – it is tough to see how Fed Chair Powell can wax significantly dovish at today’s Jackson Hole, Wyoming speech.
Our chief question, then, is first, how profound the disappointment will prove and second, how the market will react to Powell failing to come out as dovish as hopes. Positioning across markets is perhaps the best guide, but makes for a confusing mix: most obvious from a positioning angle is the clear and present danger of a chunky consolidation in bond markets and precious metals after their recent blowout rally – with Germany’s failed 30-year zero coupon auction this week another sign that absolute lows in yields for at least non-US bond markets may be near. But the currency market picture is less clear-cut and we have conflicting drivers. The safe haven currencies CHF and JPY have enjoyed recent strength, moves that look very linked to the fall in bond yields, and could thus consolidate lower if bonds are on the defensive. But how will these and other currencies perform if Powell’s speech inspires an ugly risk-off deleveraging move in equity markets? The trickiest combination here across markets would be higher long yields and lower equities
In short, precisely where the USD will strengthen is less clear than the general risk of a stronger USD in the event Powell disappoints on the hawkish side of current market pricing, while a more aggressively dovish speech than expected – for example one that sees Powell honestly outlining that the Fed will be forced to ease if, for example, the USD is materially stronger or due to the fiscal crowding out from Trump’s ballooning deficits that will eventually force its hand anyway, could see a sharply weaker USD, especially versus traditional risk-correlated currencies, whether the commodity dollars within the G10, or EM.
Sterling on the move yesterday, rallying strongly after German Chancellor Merkel made the remark that the EU and the UK have until October 31 to find a Brexit solution and said a solution could be found in the next month. Even French President Macron, who has generally put up a very stern position on any revisiting of the existing deal, said that both sides should “make the most” of the time to “find solutions”. EURGBP down through 0.9100 pivot area on this and could have farther to go to the downside if this weekend’s G7 meeting in Biarritz throws off further signs of progress, however vague.
Bloomberg reported that Bundesbank sources indicate they see no need for fiscal stimulus at this time – yet another signal that Germany will only pull its head out of the sand at a very advanced stage of economic malaise. On the other hand, Reuters ran a story discussing Netherlands’ interest in outlining a very large stimulus package aimed at investing in infrastructure and education. Still, the more important existential question for the EU will be whether stimulus can reach the periphery and how it will be funded – and whether core attitudes shift at all on fiscal union when their own economies are mired in a recession.
Chart: Dollar Index
We don’t look at the US dollar index much as it is such a Euro-heavy indicator of the broader USD exchange rate – but a number of other measures also show that the US dollar is perched near the highs for the cycle, just as EURUSD is perched near the 1.1027 lows. This Jackson Hole speech event risk looks like the classic either/or trigger for the next USD move – stay tuned, but a sharp USD move higher will more quickly bring a backtracking from the Fed if it thinks it isn’t going to cut as fast or faster than the market currently expects.
The G-10 rundown
USD – the greenback clearly at the center of the market reaction today as noted above.
EUR – rising anticipation of a dovish “last hurrah” or at least “penultimate hurrah” at the September 12. Trump will be on the warpath if EURUSD drops below 1.1000 against EU on the currency front – further risk to EU exports and Germany in particular.
JPY – a confusing mix for the yen here – will likely take its cue from long yields (negative correlation) – clearest path for getting back on rally track would be yields falling afresh with risk off. In USDJPY, 107.00 area on the weekly close an important one.
GBP – Strerling bulls have a strong case, given extreme bearish speculative positioning, if this weekend’s G-7 meeting shows signs of growing pragmatism in finding a way forward for Brexit, however tenuous. Bank holiday in London on Monday.
CHF – ditto the comments on JPY- though Brexit thaw hopes may be driving a bit of CHF weakness at the margin as well.
AUD – CNY in focus as USDCNY touched above 7.10 overnight with the CNY fix set around 10-12 bps weaker versus the USD on most days since the large move in early August. Given absurdly tight range in AUDUSD last three weeks, something has to give. Downside risk most prominent on Powell hawkish surprise combined with risk off.
CAD – USDCAD so pivotal in the 1.3300-50 area and will take its cue from Jackson Hole speech from Powell and risk appetite today. A close above the pivot zone on USD strength points USDCAD toward 1.3500-1.3600.
NZD – RBNZ’s Orr pulls the handbrake on dovish expectations for future cuts. He seemingly wants to preserve some optionality as he said overnight that “We can afford to watch, wait and observe what is happening”. This frustrates AUDNZD progress higher for the moment – but weak Q2 Retail Sales from NZ were out overnight (only +0.2% QoQ ex inflation).
SEK and NOK – the SEK rally on Riksbank rhetoric was a one-day wonder and expect SEK and NOK to move up or down passively with risk appetite in the wake of Jackson Hole speech later today.
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