Traders cut USD longs ahead of Jackson Hole

Market Brief

FX traders continued to pair-down long USD positions ahead of Fed Chair Yellen’s speech at Jackson Hole later today. In addition, risk appetite returned among equity investors, generating a strong US session. The planned meeting between Russian President Putin, Ukrainian President Poroshenko, and the EU has generated optimism that geopolitical tensions may further be reduced. Asian equity markets have rallied with the exceptions of Japan as investors have lowered the probability of a less dovish Yellen. The Nikkei fell -0.30%, the Hang Seng rose 0.28% and Shanghai was up 0.23% (at the time of writing). S&P futures are in positive territory after reaching new record high yesterday. While European economic recovery falters (highlighted by weak euro area PMIs), the US data continued to improve. Yesterday existing home sales, the Philly Fed manufacturing index, weekly unemployment claims and the Conference Board’s index of leading indicators, reports came in better-than-expected. We are fundamentally bullish on USD and see current pullback from overbought conditions, as an opportunity to reload longs. Investors on the other hand have downgraded European prospects of growth and inflation which will hurt the Europe and stifle regional equities performance. USDJPY quickly rallied to 103.95 on carry funding demand yet paired down excessive longs to 103.65 ahead of Jackson Hole. EURUSD trading was subdued rising to 1.3299 on short covering despite weak EZ data and solid US data. Perhaps USD bears were paying any attention to the hawkish comments provided by Plosser, Williams and former Fed Vice-Chair Kohn. EM Asia was broadly stronger with THB and KRW leading the pack.

Focus on Yellen

Fed Chair Yellen and ECB President Draghi are scheduled to speak today at Jackson Hole symposium. Given the FOMC minutes hawkish tone, this conference could provide an excellent opportunity for Yellen to clarify committees view. Yet, with Europe facing significant economic headwinds and financial markets already on edge, the most likely outcome is she will take a conservatively neutral tone. Yellen will Attempt to disrupt the markets as little as possible. However, language and interpretation are a tricky business. Should Yellen take the dovish path and indicate that employment and inflation targets not reached and tightening is far off, USD is likely to get sold. However, acknowledgement of the hawkish argument in the recent FOMC minutes will trigger USD buying. In light of the recent weak EU data, ECB President Draghi’s address will also be interesting. Even should Draghi steer clear of commenting directly on policy strategy, we remain fundamentally bearish on EUR, as some action will need to be taken.