FX Update: Powell speech at Jackson Hole to set the tone for weeks

Trading interest

• Maintaining long AUDNZD with stops below 1.0500 now for 1.0625 and eventually 1.0700
• Staying short EURJPY for 112.00 as long as remains below 119.50
• Long USDCAD for 1.3500+ with stops below 1.3240

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.