Jackson Hole Preview: Will Yellen lift the US Dollar?

All eyes are on the major central bankers due to speak this week at the Jackson Hole conference on 24-26th August. 

What to expect?

Mario Draghi will attend this year’s US Federal Reserve symposium in Jackson Hole; however, the ECB has already made it clear that Draghi will not be talking about the monetary policy. Thus, all eyes will be on what Yellen says. As Kathleen Brooks from City Index says, “There is a strong precedent for the head of the Federal Reserve to announce policy changes at Jackson Hole compared with the other major central banks”. 

Trump’s failure is a blessing in disguise

There is plenty scope for the Fed to quicken the pace of policy tightening… This is because Trump’s failure so far has killed the US dollar, thus Fed does not have to worry about the strong exchange rate. Imagine, if Trump had set the ball rolling right from the first day, the USD would have been way too strong, making it difficult for the Fed to proceed with rates hikes/balance sheet normalization. 

Meanwhile, US economy is chugging along pretty well… Momentum in the US economy is picking up, with the economic surprise index starting to grind consistently higher. It proves that Trump Bump, though desirable, is not necessary to keep the markets and the economy afloat. 

Yellen is more likely to throw caution to wind

…Thus, Yellen is more likely to throw caution to the wind reiterate scope for another 25 basis point rate hike later this year. Yellen may also say that balance sheet runoff is likely to begin in September. The balance sheet runoff is likely to be the Fed’s preferred policy tool in the future and the pace of normalization is likely to be glacial at best. 

Dollar Index: Scope for sharp rally

• The market is still bearish on the US dollar. Investors seem to under appreciate the fact that Trump’s dismal performance and the resulting sell-off in the USD has actually created more room for the Fed to normalize its policy. Furthermore, there is now a less than 50% chance of a rate hike in December. 
• Thus, the stage is set for a sharp rally in the USD if Yellen talks about balance sheet runoff in September and hints another rate hike in December. Stocks could sink, yield curve would steepen beyond 96 basis points if Yellen's comments hint at a faster balance sheet unwind.
• Investors need to keep an eye on the yield curve [spread between the 10-yr yield and 2-yr yield]. A steeper yield curve after Yellen speech would add signal the dollar rally is sustainable. As discussed here, a break above descending trend line hurdle of 0.96 basis points would also signal a bullish trend reversal in the US dollar. 

Dollar Index - Bearish exhaustion noted around 93.00

Weekly chart

• Multiple weekly candles with long tails signal bearish exhaustion near 93.00 levels. The RSI is attempting a turnaround from the oversold territory. 
• A break above the recent high of 94.20 would open up upside towards 95.50 levels. Further gains appear unlikely in the short-term, given the 10-MA on the weekly chart is still sloping downwards. 
• On the downside, only a weekly close below 92.55 [weekly 200-MA] would open doors for 90.00 levels. Such a move appears likely if Yellen drops a dovish bomb.