Trade of the Week: USD Index back above 1.20?

August 22, 2022

– Shame on those who doubted the Dollar (at least of late).

The greenback has staged a recovery and is on a quest to revisit recent highs, as markets restore their bets for an ultra-hawkish Fed.

As a result, major G10 currencies are wilting under the weight of the resurgent buck:

EURUSD is flirting with parity again, having last done so in mid-July.
GBPUSD also hit a one-month low, trading around levels not seen since the onset of the pandemic.

Such moves are captured within the equally-weighted US Dollar index, which measures the greenback’s performance against these six G10 currencies:

As a result, this USD Index is retesting the mid-1.19 resistance levels which had previously repelled dollar bulls in mid-May and mid-June, also around where the 61.8% Fibonacci retracement level currently sits from its July-august descent.

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Whether or not the US dollar can punch higher and break above the psychologically-important 1.20 level could well depend on what’s conveyed out of the Jackson Hole Economic Symposium later this week.

What is the Jackson Hole Symposium and why it matters?

Organized by the Kansas City Fed, this year’s gathering will be held from August 25th – 27th in Jackson Hole, Wyoming (though recent symposiums have been held virtually as well due to the pandemic).

This annual conference features the top central bankers, economists, academics, and even government representatives, where they discuss the most important issues facing the global economy, as well as how policymakers could and should respond.

In other words, what is said during this closely-watched symposium has the potential to prompt market participants to move trillions of dollars across asset classes including stocks, bonds, and currencies.

And Fed Chair Jerome Powell’s speech that’s scheduled for this Friday, August 26th, at 2:00 PM GMT, is set to dominate the market’s collective attention this week.

What Powell says (or doesn’t say) could dictate how global markets perform in the weeks ahead.

What markets want to know out of Jackson Hole?

Markets want to know how much the Fed intends to raise US interest rates for its September meeting, and beyond.

1) As things stand, markets are forecasting a 63.7% chance of yet another 75-basis point (bps) hike by the Fed at its September policy meeting.

Those odds have been increased substantially from 46.8% just from this time last week. Hence, the US dollar rising over the past week in tandem with such restored bets.

If the Fed does proceed with yet another 75bps hike, that would be its third successive supersized hike, following similar 75bps hikes at each of the Fed’s policy meetings back in June and July.

2) Markets also presently believe that that US benchmark rates could go up as high as 3.7% by May 2023, as the Fed continues aggressively raising interest rates to combat multi-decade high inflation.

Major deviations from the above (the existing narrative that markets are holding on to at present) should result in major moves for the US dollar.

Potential scenarios for USD Index:

Should Powell signal that the Fed has to stay aggressive to bring down US inflation (think more 75bps hikes in Q4), that could mean more immediate gains for the US dollar.
If the 1.20536 Fibonacci level can be conquered, then this equally-weighted USD Index could be on the path to revisit the mid-July peak above 1.21.

However, if Powell officially signals that the Fed can start to ease up on its rate hikes on signs that US inflation has peaked, that could prompt the unwinding of last week’s gains for the US dollar.
Support may arrive at the:
– previous cycle high of 1.19102, followed by …
– the next Fib line below at 1.18769
– 50-day simple moving average around 1.183

Despite the Fed’s suggestions to pay less attention to what it says it will do (forward guidance is less meaningful over the immediate term), but instead pay greater heed to the incoming US economic data (such as nonfarm payrolls and CPI), that likely won’t be enough to dissuade forward-looking investors and traders worldwide from reacting to Powell’s policy clues.