The Dollar Is Back! What To Expect At Jackson Hole

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

The U.S. dollar is back but the Australian dollar is in trouble. After falling in the front of week, the greenback regained momentum on Thursday to trade higher against all of the major currencies. Nothing came out of trade talks between the U.S. and China – both parties moved ahead with tariffs on $16B worth of goods, so the focus shifts to the Federal Reserve’s annual economic symposium at Jackson Hole. It’s a 3-day meeting that begins Thursday night and all of the major speeches will be made on Friday starting with Jerome Powell’s remarks at 10 am NY. This will be his first symposium as Fed Chair. We know BoC Governor Poloz will be attending but BoJ Governor Kuroda is skipping the event and its not clear whether BoE Governor Carney, who did not attend last year, will appear at the event. The ECB’s weekly schedule does not show a speech at Jackson Hole for ECB President Draghi but we’ll know for sure when the Fed releases its detailed schedule at 8 pm NY time Thursday.

Three things To watch In Powell’s Speech:

1. Will he acknowledge President Trump’s comments?
2. How much will he say about the impact of trade tensions
3. Will he prepare the market for less aggressive tightening after September

Earlier this week, President Trump sent the dollar tumbling when he lamented about Fed tightening. Its not the first time that we’ve heard the president criticize his fed chief and it won’t be his last. However the best way for Powell to handle Trump’s comments is to ignore them. There’s no winning in going against his boss or even agreeing with him, which would suggest that the central bank has lost its independence. So the only response is no response at all. The Fed may slow down tightening, but it won’t be because of presidential pressure. On the other hand, Powell could have a lot to say about trade and the global economic outlook, which is slowing. According to the FOMC minutes, even before Jackson Hole, policymakers were worried about trade, housing and emerging markets. If Powell suggests that this could affect the U.S.’ economy outlook, the dollar could take a hit. Investors will be looking for any indication of possible slowing of Fed tightening. Not only could it be necessary because of slower growth, but the yield curve is at risk of inverting, which is troubling for many businesses and policymakers. There’s no question that the Fed will raise interest rates in September but if Powell uses Jackson Hole as the venue to start talking about a change to guidance, the impact on the markets and the dollar could be significant (we could see USD/JPY back at 110). However if Powell refrains from any new revelations or guidance, USD/JPY could extend its gains to 111.50 and EUR/USD could drop to 1.15.

Since it's not clear at this time whether Draghi or Carney will be at the meeting, Bank of Canada Governor Carney’s speech will be the other one to watch. The market expects the BoC to raise interest rates before the end of the year and Carney could use this opportunity to confirm or cast doubt on the possibility of a year-end tightening. While data has been fairly good, Canada’s central bank has yet to commit to a hike because of trade uncertainty so the Canadian dollar will be in play on Friday.

Meanwhile, political troubles in Australia sent the Australian dollar tumbling more than 1%. Prime Minister Turnbull faced another leadership challenge after his own party pulled its support. Adding fuel to the fire according to our colleague Boris Scholssberg, was the Australian government’s decision to ban Chinese maker Huawei (SZ:002502) from participating in the build-out of the 5G infrastructure on security grounds. The news is sure to further aggravate the already shaky Sino-Australian relations and could be a source of pressure on the Aussie. The pair dropped below the .7300 figure and appears poised for a test of .7200. NZD fell in sympathy with AUD and also appears to be headed lower with a test of 66 cents in the cards.

The recovery in the U.S. dollar also sent euro and sterling lower but the euro was the day’s most resilient currency thanks to comments from BUBA President Jens Weidmann and economic data. Economic activity in the Eurozone expanded at a faster pace in August according to the PMIs. Led by gains in the service sector, the composite index for Germany rose to its strongest level since February. The manufacturing sector, however, is beginning to feel pressure from trade tensions. Weidmann, who is widely believed to be Draghi’s successor, talked about the need for policy normalization. He described Germany’s economy as flourishing and said it's time to exit from very expansionary monetary policy. There was no specific driver for the slide in sterling but the rejection of the 20-day SMA at 1.29 signals a move back to 1.2700.