Speculative flows to dominate ahead of Jackson Hole symposium

FX risk trends failed to adhere to respectable gains from U.S equities on Friday, despite hopes central banks from both sides of the Atlantic will soon unleash a new wave of policy easing measures. True to form, speculation surrounding the Fed’s near-term easing plans remained in the headlines with market participants focusing on a letter from Fed Chairman Ben Bernanke in reply to questions from the Chairman of the House oversight committee, Darrell Issa. Bernanke wrote “there is scope for further action by the Federal Reserve to ease financial conditions and strengthen the recovery.”

Investors also focused on fresh reports the ECB may cap borrowing costs of Europe’s struggling periphery, with a Reuters report quoting a central bank source as saying a yield cap “is one of the options that is currently being discussed in the working groups and will then be handled by the Governing Council.” Still, many economists consider this an unlikely scenario, given the stress it would place on the European Central Bank to continually intervene in an effort to keep borrowing costs in-line with predetermined yield or spread differential targets. Although rumour and innuendo over exactly what actions the European Central Bank can/will take in their next policy meeting persist, it appears markets are increasingly taking each rumour and counter rumour with a grain of salt.

Despite a late reversal, the greenback remained under the Euro’s thumb over the course of last week with a squeezing out of Euro short positioning prompting a 1.5 percent gain from the EURUSD pair. Similarly, the dollar held a southbound trajectory against its safe-haven rivals the Swiss franc and Yen driven in part by an increase in expectations the Fed will soon embark on a fresh round of stimulus.

This week will see a similar theme guide markets with investors transfixed on Friday’s gathering of the world’s central bank elite in Jackson Hole, Wyoming, for the annual Kansas City Fed symposium. In recent years the event has attracted increased attention in light of the common challenges faced by global central banks, as a result of the financial crisis. The meeting is also seen as a platform for leaders to discuss future policy decisions, notably Fed Chairman Ben Bernanke used the event in 2010 to signal a second round of quantitative easing. Markets are clearly looking for Bernanke to elaborate on recent Fed commentary showing a willingness to embark on further easing initiatives should incoming data points fail to show a “substantial and sustainable strengthening in the pace of the economic recovery.”  Although Fed members have individually displayed their conditional tick of approval should the economy falter, it’s unlikely Bernanke can be any more succinct than his letter to the Chairman of the House oversight committee, Darrell Issa, last week, which stated “there is scope for further action by the Federal Reserve to ease financial conditions and strengthen the recovery.” Nevertheless, speculative activity ahead Friday’s meeting will be high, reflecting the constant changes in expectations as market participants look to each incoming data point to gauge how this may sway the chances of imminent policy easing. Among a host of influential data points due for release, top-tier data on this week’s docket includes a revision to second-quarter GDP on Wednesday, an anecdotal view of economic conditions from the Fed’s beige book on Thursday, alongside the release of July’s personal consumption expenditure data. Data on the health of U.S housing, consumer confidence and factory orders will also be watched closely ahead of the Jackson Hole conference.

In the absence of local market moving releases, we anticipate the Australian dollar’s performance this week will be closely tied to U.S stimulus expectations ahead of Friday’s Jackson Hole symposium. Mid-tier releases this week will see the focus remain on China with the industrial profits and leading index on the docket, while local releases include HIA new home sales, private capital expenditure and private sector credit. From a local perspective, market participants are well informed given the recent host of commentary from the RBA, suggesting local directives will take a back seat to central bank expectations emanating from both sides of the Atlantic in addition to the growing possibility of new stimulus initiatives from China.