Here’s how Jackson Hole could impact the dollar, bonds and emerging markets

By ANNEKEN TAPPE AND SUNNY OH 


          The spotlight will shine on Jerome Powell /  Alex Wong/Getty Images



Wall Street investors are watching a key gathering of prominent central bankers at Jackson Hole, Wyo., which could have implications for an array of assets, from international stocks and bonds to emerging-market assets.

The policy-maker proceedings started on Thursday, headlined by a speech from Federal Reserve Chief Jerome Powell at 10 a.m. Eastern on Friday.

Here’s what investors will be acutely watching as the meeting gets underway:

The U.S. dollar

Powell could hint at changes to monetary policy in his speech, though market participants aren’t prescribing a high likelihood of this outcome. On the other hand, Powell could talk about continuing trade tensions, notably between the U.S. and China, and their possible effect on the pace of interest-rate hikes, which he has tentatively touched on before.

“We think [Jackson Hole] is relevant in the context of extreme sentiment and positioning in favor of the dollar,” wrote Mark McCormick, North American head of FX strategy at TD Securities. “That leaves asymmetric risks to the dollar, as any signs of caution would reinforce a short-run positioning squeeze.”

In September, the Fed is expected to raise interest rates for an eighth time since late 2015, with fed-funds futures indicating a 96% probability of a hike. But a potential fourth hike of the year in December is less certain, at only 65.3%. Any additional guidance from Powell on the pace of policy tightening could alter the overall expectations for rate increases.

Complicating the Fed outlook, President Donald Trump suggested Monday at a fundraiser in the Hamptons that Powell was not as dovish as he had hoped. Though the central bank is likely to ignore criticism that it is normalizing monetary policy too swiftly, Trump’s comments “marginally increases the likelihood that the Fed will hike again in December to avoid any perception of political sensitivity,” said Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets, in a note.

Doubts about the health of emerging-market economies, sparked a by a shift into U.S. dollars amid concerns about negative effects from intensifying spats between the U.S. and other trade partners, also have been a focus in recent weeks. Market participants say a strengthening trend for the dollar, which has gained against emerging-market currencies and larger economies, has left it stronger than it should be, putting it in position for a possibly firm pullback against rivals.

According to data from the Commodity Futures Trading Commission, the number of bullish bets by speculators surpassed bearish wagers to hit a one-year high as of last Tuesday.

The ICE U.S. Dollar Index DXY, +0.58% , which measures the buck against six rivals, has strengthened 0.8% in August, and is up 3.6% year to date, according to FactSet data.

Emerging markets

The dollar’s strength has come at the expense of emerging-market assets. A stronger dollar has meant that emerging-market nations with heavy dollar-denominated bets face fiscal instability if they use local currencies to service outstanding loan obligations. Moreover, higher interest rates can make emerging-market assets less appealing, compared against the risk, relative to other assets like, U.S. government bonds, for yield-seeking investors.

If trade tensions are spotlighted, EMs could come under further pressure, leading the dollar higher in response, market participants said .

On top of that, the unwind of the Fed’s multitrillion-dollar balance sheet, which peaked at some $4.5 trillion, is hugely important for emerging markets, as it impacts global liquidity. Shrinking the Fed’s portfolio of assets would possibly drive down Treasury prices and lead yields inversely higher.

“The big question for global investors is whether the Fed not only acknowledges the recent market volatility, but also the fact that its own policy signals may be partly behind the deterioration in global risk sentiment,” wrote ING FX strategist Viraj Patel. “Under a Yellen Fed, we were pretty sure that these market conditions would have kept the US central bank in wait-and-see mode; however, all eyes will be on new Fed Chair Powell to see whether he formally adopts an ‘America First’ monetary policy approach.”

If Powell turns a Yellen-esque corner in his comments, EM assets could get some respite, Patel suggested.

Treasurys

Even if Powell does use the podium to give guidance on future rate hikes, traders are likely to see few surprises.

The strong economic backdrop and Powell’s consistent messaging on the need to normalize interest rates have already pushed investors to price in three to four hikes this year. Yet the nearly universal market expectation that the Fed will continue to raise rates hasn’t helped bond bears, who have steadfastly expected rates to hit, and remain above, 3%.

Instead, the yield curve — the gap between short-dated rates and longer-dated peers — has steadily flattened as geopolitical turmoil and fears of a trade war have anchored long-dated rates while nudging short-dated yields, the moves sensitive to Fed policy moves, higher. In August, the 10-year Treasury note yield TMUBMUSD10Y, +0.06% has slipped around 14 basis points to 2.83%, while the two-year note yield TMUBMUSD02Y, +0.32% has fallen 7 basis points to 2.60%, according to WSJ Market Data Group. That helped to narrow the yield gap between the two maturities, one of the most popular measures of the yield curve’s slope, to 23 basis points, or 0.23 percentage points, its tightest since early August 2007.

Fixed-income investors are likely to fixate on the bond market’s attention on the endpoint to the Fed’s balance-sheet reduction.

Terminating the balance-sheet runoff sooner than investors expect means the Treasury Department wouldn’t need to increase net issuance as much as planned. That’s because with a larger balance sheet, the central bank will absorb more of the supply as the pace of its monthly reinvestments would also run higher. Falling net issuance could thus give relief to the short end of the bond market, which has seen yields steadily rise, thanks in part to a deluge from this year’s lift to budget spending caps and a more-than-trillion-dollar tax cut.

“Should Powell hint that a larger balance sheet would be a reality the Committee is comfortable with, an earlier end to SOMA runoff would clearly be interpreted as very dovish, with the most immediate takeaway the realities of less Treasury issuance,” said Lyngen. SOMA refers to the System Open Market Account Holdings and amounts to the Fed’s total portfolio of securities.

Although seismic shifts are not expected, a lack of further market drivers including earnings and major data in the near-term could make the central bank convention a main attraction for Wall Street.

“Thus far Powell has been more Yellen than Bernanke in terms of jawboning the market, so we view the chance of any paradigm shifting remarks as low, but present,” said Lyngen.