USD: Will Yellen Disappoint at Jackson Hole?

The U.S. dollar has been treading water for most of the week as investors wait with bated breath for Janet Yellen's speech on at Jackson Hole on Friday.  This annual gathering of central bankers is an important opportunity for policymakers to discuss the global economy and monetary policy in a public but informal setting.  Yellen skipped last year's meeting so her attendance this year is eagerly anticipated.  One of the main topics up for discussion is the global experimentation with negative rates and inflation targeting.  Last week San Francisco Fed President John Williams talked about abandoning the inflation target, keeping rates low for longer and possibly even considering negative rates.  While he later said that raising rates soon is justified, he brought up 2 significance issues for many central banks. There will be numerous discussions on important topics such as these at tomorrow's summit but the market only cares about one thing - how eager Janet Yellen is to raise interest rates in 2016. 

As we mentioned earlier this week, the Fed's leadership drives U.S. policy and we know Dudley and Fischer believe that rates could rise this year.  Investors are prepared for similarly hawkish comments from Janet Yellen but the key question is - will that be enough.  Over the past few months we've seen how skeptical investors have been about the guidance from central banks.  Even though the ECB, BoE, BoJ and RBNZ have signaled plans to ease again, their currencies are trading well because data hasn't been terrible or in the case of Japan, the central bank keeps coming up short.  Most Fed officials believe that rates could rise this year but Fed fund futures show that investors aren't convinced. 

So for the dollar to rise, investors need Janet Yellen to be extremely explicit about the timing of the next rate rise. Anything short of that and the squeeze higher in the dollar will be short-lived.  She needs to say that rates will NOT may rise before the end of the year and ideally indicate that it will be coming in the next few months (ie. December).  Unfortunately we don't think she will deliver.  While the job market is clearly recovering, the performance in other parts of the economy has been uneven.  Of course if we are wrong and she sends a very strong message to the market about tightening in December or sooner, the dollar will soar.  In addition to Yellen's speech, the trade balance, revisions to second quarter GDP and the University of Michigan consumer sentiment index are scheduled for release tomorrow.

Euro traded higher against the U.S. dollar today despite weaker business confidence in Germany.  This is the first time in 4 trading days that we have seen a rally in EUR/USD so today's move may be nothing more than a bounce after a series of losses. Investors grew less confident about current and future economic conditions in the Eurozone's largest economy with the IFO business climate index slipping to its lowest level in 6 months. Many have been crediting this deterioration to delayed Brexit shock for German businesses. According to our colleague Boris Schlossberg, "The irony of Brexit is that its single biggest impact may have been on German sentiment as highly export driven German businesses became clearly concerned about the prospect of UK leaving the EU. According to IFO, order intake from chemical and electrical sectors was subdued which may have weighed on sentiment as well. Germany, as the export powerhouse of Europe has the most to lose from UK's exit from EU, but the sharp fall in IFO reading may be more a result of fear rather than reality. So far neither the UK data nor the EZ Flash PMI data have shown any material deterioration of demand"

In contrast sterling lost value against the U.S. dollar today despite a higher CBI Distributive trades report.  While this number is not very market moving it is important because of its strong correlation with the broader retail sales index.  The sharp rise in CBI suggests that the impact of Brexit on consumer spending has been limited.  However we believe today's report is catch up from last month's release since the official retail sales report for July was very strong. Revisions to U.K. GDP will be released but there are generally no changes since the Brits tend to do a good job of estimating their data.  Bank of England Deputy Governor Shafik is scheduled to speak at Jackson Hole on Friday.

All three of the commodity currencies traded lower today.  There were no economic reports from Canada, Australia or New Zealand which means their strength were caused purely by the rally in the U.S. dollar.  AUD/USD and NZD/USD are exhausting near recent highs and the question of whether this pullback becomes a top lies with Yellen's testimony on Friday.