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Traders look to Jackson Hole for dollar’s direction

Investors hoping for something to bite on in the dog days of August cannot have failed to notice one major event that may go some way to determining the direction of the US dollar.

The annual symposium of central bankers at Jackson Hole in Wyoming, starting in two weeks, is always a must-watch market event, but it could be especially eye-catching this year.

Last year’s symposium marked the start of a 19-week rally in the dollar index — a measure of the greenback against other major currencies known as the DXY — that was kicked off by hawkish remarks from Janet Yellen, Federal Reserve chair.

The market is expecting more of the same this year — but not from Ms Yellen. Instead, traders are anticipating the possibility that Mario Draghi, president of the European Central Bank, may give hints that the eurozone’s monetary guardian is about to sound the retreat after more than two years of quantitative easing.

Such a stance could add momentum to this year’s euro rally, so far amounting to an 11 per cent increase against the dollar, and spell further trouble for the DXY, in which the common currency has a 58 per cent weighting.

For sure, investors have fallen out of love with the dollar since the turn of the year as hopes have faded that the new president’s policies could lift the economy. The Trumpflation trade, which helped propel the dollar index to a 14-year high near just below 104 at the start of 2017, has “withered on the vine”, says Alan Ruskin at Deutsche Bank.

The index is now around 93, below the level of a year ago, having suffered the worst first seven months of the year since 1986. “We have been on one wild round trip,” Mr Ruskin adds.

President Trump’s political trauma, which includes turmoil in the White House and a strained relationship with his own party, have compromised his ability to push an economic agenda of fiscal stimulus and tax reform, and that policy stasis is one of the four reasons why the dollar may remain under pressure, analysts say.

“Consider that in November the Republicans in Congress rode his coat-tails — now he has no sway in pressuring members to be united on healthcare reform and other legislation,” says Steven Englander of the Hong Kong hedge fund Rafiki Capital.

Republican division and Democrat intransigence is putting paid to “the best chance for tax reform in 30 years”, the result being a dollar that is responding to a “do-nothing” Congress and White House, he adds.

A second reason is the impact that negative political news is having on investor sentiment more broadly toward the US. Look at the currency’s reaction in May when it was first reported that Mr Trump asked ex-FBI director James Comey to close the bureau’s investigation into ties between former national security adviser Michael Flynn and Russia, says Simon Derrick of BNY Mellon.

The dollar fell against the yen by more than 2 per cent in one day.

“To put this into context, this put it into the top 100 daily declines seen in dollar-yen since the Nixon shock,” says Mr Derrick.

Mr Englander paints a more troubling story for the dollar, one that sees White House turmoil descend to the point where “the only show in town is politics” and foreign countries take advantage of the chaos to gain foreign policy objectives against US national interests. “This is the dollar index at 80 story,” says Mr Englander.

Reason number three is the US economy’s performance in comparison to that of the eurozone.

A weakened dollar is not having a material impact on the US economy, Mr Ruskin says. If anything, it has supported earnings and at some point will help exports. But there are two sides to exchange rates, he adds, and since May “a key element has been euro strength, and perhaps that is more important than dollar weakness”.

Recent data show an acceleration in eurozone GDP growth, strong manufacturing activity and the lowest level of unemployment since 2009. Meanwhile, despite the US economy growing by a healthy 2.6 per cent in the second quarter, investors would prefer to focus on meek inflation, judging by the dollar’s performance.

Upbeat US payrolls data for July last week provided only a temporary boost for the dollar, suggesting that the market needs to see a much stronger pace of wage gains in order to break the currency’s bearish trend.

These factors contribute to the fourth reason for dollar weakness, the contraction in monetary policy divergence as the ECB and other central banks move towards policy normalisation.

The Fed has broadly delivered on its rate promises, says Mr Ruskin, indeed it has gone further than the market expected before the US election. The dollar strengthened as the Fed diverged from other central banks, “but that story has been turned on its head”.

Which is where Mr Draghi comes in. Should the ECB president at Jackson Hole cement expectations that the era of his monetary largesse is drawing to a close then traders may make more bets on the convergence of US and eurozone central bank policy — boosting the euro and hitting the dollar.

So how could the dollar turn things around from here? Its best hope is a technical correction. The dollar index is heading for the May 2016 low of 91.91, at which point currency positions would be close to the extremes of 2008, analysts note.

A break through this level would see the dollar bull cycle “well and truly cracked” and the dollar facing a bigger slide, says Mr Ruskin, which suggests the market will heavily resist such a breach.

That may stop the rot, but it is a long way from driving a sustained recovery. As Marc Chandler at Brown Brothers Harriman says, “the tide of sentiment has turned against the dollar”. Jackson Hole is unlikely to halt it.