There is a lot of expectation that this week’s Jackson Hole conference from 24-26th August will deliver some much-needed direction to the markets. However, movement in the FX market suggests that we may be expecting too much from global central bankers’ as a global race to the bottom in the FX market is currently taking place.
Markets ignore central bank pleas
Earlier on Tuesday the Thai central bank voiced concern about speculators pushing up the Thai Baht, which had virtually no impact on the Thai currency as the market has been willing to disgard central bankers’ abilities to push down a currency with just words alone. This was also the case for the Reserve Bank of Australia, who touted the prospect of intervening to weaken the Aussie if its strength threatened the Australian inflation rate. However, the AUD is the second strongest performer in the G10 vs. the USD since June.
The ECB also mentioned the risk of the euro overshooting to the upside in the minutes of its latest meeting. The impact of this news was only short-lived for the euro. The Swedish Riksbank may delay hiking rates even though inflation is above the 2% mark, in a bid to stem SEK strength, after the Swedish Krona rallied more than 13% vs. the USD since the start of this year. The Bank of England has stayed on its dovish course and not even the prospect of an earlier than expected rate hike some time in 2018 could shift sterling from its position as the worst performer in the G10 vs. the USD so far this year.
The race to the bottom in G10 FX
Right now the FX market is facing a glut of central bankers who are desperate to talk down their currencies, however, mostly the FX market is ignoring what central bankers have to say and focusing on two things: firstly, the improving economic fundamentals that are driving the euro, Aussie dollar and Swedish krona higher. Secondly, the race to the bottom in the G10 FX space has triggered a wave of money into emerging market FX, which is why the Mexican peso, Czech Koruna, Serbian dinar and Mozambique New Metical are the top five best performing currencies vs. the USD so far in 2017.
Currency wars: Emerging Markets fight back
Comments from the Thai central bank on Tuesday suggest that emerging markets will not sit idly by and let their currencies appreciate to economically damaging levels. This could be the start of currency wars part 2, and it may not be pretty for the FX market for the rest of this year.
Jackson Hole: don’t expect Draghi to break the mould
Back to Jackson Hole, the market is primed for central bankers’ to talk down their currencies, which means that any “hawkish” talk may cause the biggest waves in financial markets. The focus will be on the ECB’s Mario Draghi and the Fed’s Janet Yellen. We believe that Draghi will likely tread cautiously and won’t give anything away about ending the Asset Purchase Programme. While he may acknowledge growth has picked up, he is likely to sound concerned about inflation and may even reiterate the ECB’s concern about a euro overshoot to the upside.
Yellen the maverick
Janet Yellen is the one to watch, in our view. Her time as Fed Chair most likely coming to an end in January, which may cause her to throw caution to the wind. Yellen may use the Jackson Hole conference as an opportunity to explain why the Federal Reserve has been willing to hike interest rates even while inflation has been slowing. Her argument in support of rate hikes in a low inflation environment could be perceived as hawkish, which is likely to be dollar positive in our view.
Our dollar view explained
This leaves a resumption of last week’s stronger dollar trend as the most likely outcome from this Jackson Hole conference, in our view. So, how high could the dollar rise? We think that any “hawkish” comments from Yellen could be enough to boost the dollar in the short term, at least. As you can see in the chart below, there is the beginning of a nice up trend in the dollar index after key support at 93.10 held. Above here opens the way to 95.00, the 50-day sma, in the short term, ahead of 96.80 – the 38.2% retracement of the Jan high to early August low. A 300 pip move may sound like a lot, but if Yellen stands out as the only major central banker not talking down her currency then the dollar bulls are likely to take charge.
Source: City Index and Bloomberg