Kansas City Fed’s annual symposium held in Jackson Hole, Wyoming is turning into this year’s most anticipated event when it comes to US monetary policy. While Jackson Hole rarely disappoints the “Econ-Geek” in all of us, traders are on high alert after a befuddling policy divide amongst Fed members and will keenly view this year’s symposium for any tidbits or clues in future directions of monetary policy.
The table was set after influential Fed members took to the wires in discombobulated fashion, when July’s FOMC minutes uncovered a dovish-leaning board in contrast to the hawkish-siding regional Fed presidents. Even more impressive was the fact traditional dovish-leaning presidents flew to the hawk’s nest, with one even managing to fly back and forth.
Traders would be wise take serious note of last week’s events while considering that the Fed may restart a path of gradual rate hikes, which was mothballed in early 2016. In January, interest rates were pigeonholed due to fears of a China economic slowdown and if not for May’s NFP outlier and the Brexit-induced pause, we may be debating a second 2016 rate hike at this juncture.
Investors heeded these warnings on Friday after the San Francisco Fed President John Williams followed his speech in Alaska with the comment that September’s FOMC meeting is in play. Consequently market pricing for a Fed rate hike this year poked above 50%, with bond yields prodding higher across most markets and the USD re-faced the sun.
As for Brexit, it is unlikely that price adjustments in Foreign Exchange and other asset classes are entirely played out. So far, the financial system has performed admirably under the strain and that should give Fed members the confidence to lessen policy accommodation gradually without fearing upheaval in the financial markets.
China remains a wildcard as traders continue contemplating the rumors about an agreement between US and China to keep interest rates from rising too fast or unexpectedly. Early in the year, the Fed was clear about the global impact from Chinas economic slowdown, but less so of late with the RMB remaining calm.
As the G20 Hangzhou summit is slated for Sept 4-5, there is even less incentive for Dr. Yellen to rock the boat at Jackson Hole, as China likely has conferred plans to reveal some form of policy measures at the G20 summit.
The FOMC reconvenes on September 20 and while it is unlikely, traders have underpriced the possibility of a September rate hike. Investors need to be on guard for a significant jump in odds for December and beyond. Currently, the probabilities are pegged at 22% (Sep) and 51% (Dec), respectively, based on Fed funds futures.
Ultimately Dr. Yellen will view September’s Fed futures-based probability as ample justification to delay the rate hike, as the Feds have not rightfully guided the futures market to the appropriate 50-70% level for fear of creating unnecessary market turmoil. It’s unlikely that Jackson Hole will be the catalyst for that swing.
Perhaps the rate hike nudging by Fed speakers is designed to prepare the market for December. The Federal Reserve Board will not tighten without guiding the futures markets to at least a 70% probability as they will not ignore the lesson of 1994, when a surprise Fed rate hike was followed by “The Bond Market Massacre” of 1994.
Aussie Dollar – A Falling Star
The Australian dollar was a falling star after Moody’s Investor Services cut their outlook on domestic banks to negative from stable while highlighting a plethora of reasons including low pay increases, record low-interest rates and rising household debt for the decision.
Keep in mind, Australian Banks are amongst the higher rated banks in the world but are facing increasing bad loan provisions from the mining sector and households in those respective regions due to job loss.
Keeping things in perspective, Standard and Poor’s placed Australian Banks rating on negative back in July based on the fact that Australian Banks borrowing cost would accelerate if the Federal Government came under debt rating pressure.
While it’s hard to avoid short-term volatility on the back of debt agency musings, currency reactions to rating downgrades tend to be short lived, as we’ve seen so often in the past.
However, the "higgledy–piggledy" Price action during the past few session indicates that traders are at a minimum starting to re-think the low volatility carry strategy underpinning the Australian dollar. The rejection of .7700-20 zone in the face of supportive Employment Data does suggest the Aussie bears are gradually awakening from hibernation believing the Aussie is topping.
Whether the particular trigger is the rating agency outlook or the shift in Fed rhetoric, the truth likely lies somewhere in the middle.
The Australian dollar is back pressuring the .7600 level after the USD has opened a bit higher across most majors following weekend remarks by Fed Vice Chair Stanley Fischer, the elder statesman on the FOMC who’s roosting with the hawks.
Reflecting on the Fed’s dual mandate, Fischer told a Colorado audience that “so we are close to our targets”, noting the core PCE inflation was “within hailing distance” of 2% and unemployment "close to most estimates of the natural rate."
On the domestic front, we have a relatively quiet week so external factors will drive the Australian dollar. But we should expect an uptick in volatility to muddle through during the build up to Chairperson Yellen’s August 26 speech at Jackson Hole.
There are many hurdles needed to overcome for a September US rate hike, which should provide enough excuse for Dr Yellen to press the "pause" button once again, likely deferring the decision until December. This outcome could appeal to the commodity currencies and provide a tailwind for the Aussie bulls.
Japanese Yen – Apprehension Dominates
USD/JPY is expected to trade within the broader ¥.99- 102 range near term.This morning we’ve perched apprehensively today as the USD has opened a bit higher across most majors following weekend remarks by Fed Vice Chair Stanley Fischer, the elder statesman on the FOMC who is roosting with the hawks.
Also adding to the USD/JPY bounce were traders interpreting BoJ Kuroda comments on Saturday delivered to the Sankei News regarding a comprehensive policy review in September, hinting the BoJ may venture into a deeper negative territory on interest rates, but he didn’t change his view on helicopter money. More of the same from my seat.
However, there has been good selling interest above ¥100.70 in early trade with the Fed dovish element in the market selling into this morning's USD bounce.
With this round of cards dealt, there appears neither sufficient reason or cause to either "Raise" bets or "Fold" cards at this juncture. And while lacking conviction in either direction, the threat of intervention may provide sufficient buffer to keep the downside momentum temporarily in check in the face of Fed policy uncertainty.
Beyond the veiled threats of intervention, traders continue discounting the BoJ's ability to stem the strengthening yen tide, and if as expected Dr Yellen maintains a dovish Fed track, traders will be quick off the mark testing the BoJ resolve and will likely assault the Brexit ¥.9902 lows.
Yuan - Not Much To See Here
Expect another week of tight ranges to prevail in the lead up to the G20 in Hangzhou. Given this is the marquee event in China for 2016, there’s huge motivation for policy markets to keep markets stable.
And while there will be some intermittent externally induced volatility from US economic data and Dr Yellen Jackson Hole speech, the market is not overly concerned about any internal or external unexpected policy shock. Lack of overall enthusiasm should keep the RMB currency complex running in neutral until the G20.
Ringitt – Stars Align
We could see an extension of the ringgit rally below 4.00 USD/MYR this week with oil prices continuing to rise and resumption of the USD downtrend after the greenback had its day in the sun on Friday.
The expected catalyst for the US dollar will be increasing expectations that the Feds will remain in "pause" for a cause mode, while oil prices should remain supported by OPEC production freeze speculation.