Why Jackson Hole is key for dollar

After a calm and boring summer of trading, the currency market is getting exciting again with the dollar breaking out to an 11-month high.

Things could heat up even further for foreign exchange, as global central bankers convene in Jackson Hole, Wyoming, for the Kansas City Fed Symposium.

The dollar index is at the highest level since September. The euro has broken below 1.33 for the first time since that month. The dollar/yen has fought back to levels last seen in April.

Kiyoshi Ota | Bloomberg | Getty Images

Kiyoshi Ota | Bloomberg | Getty Images

What’s behind the recent moves to these highs? It’s become apparent to forex traders that the world’s central banks are increasingly diverging in their policy paths.

Read More Investors too complacent on rates: Fed’s George

The U.S. economy is outperforming, and the Fed is seen as being the first major actor when it comes to normalizing interest rates from unprecedented crisis lows.

“The essence of a multiyear strong dollar story is U.S. dollar policy divergence, particularly with the ECB and BOJ, but more generally an expectation that the Fed will be hiking rates more than any other G-10 central bank in the next three years,” said Alan Ruskin, chief forex strategist at Deutsche Bank.

Here’s what could move exchange rates and supercharge this dollar rally, when policymakers speak in Wyoming.


European Central Bank President Mario Draghi speaks Friday, after Fed Chair Janet Yellen. Investors are eager to hear about how he plans to fight a recent economic slump across the 18-member euro zone and the dangerously low inflation rate of 0.4 percent.

Remember, the ECB’s sole mandate is to keep prices rising at just under a 2 percent rate, so not only is it missing its target, but it’s getting dangerously close to deflation. In June, Draghi lowered the deposit rate below zero and the main interest rate to a record low. He also announced other liquidity-boosters, including a new program designed to spur lending.

Importantly, Draghi recently signaled that he’s willing to do more if the outlook gets worse.

Earlier this month, during a monetary policy press conference, Draghi said, “The Governing Council is unanimous in its commitment to use unconventional policy measures like ABS purchases, like QE, if our medium-term outlook for inflation were to change.”

When Draghi speaks at Jackson Hole, investors will keenly listen for any further discussion on this to learn more about this quantitative easing-like plan to buy asset-backed securities. Any hints of action to fight deflation and a weaker economy could move the euro even lower.

Already since the June meeting, the euro has fallen nearly 3 percent against the dollar, one of the indirect goals of easing.

Bank of Japan

The other easy-leaning central banker attending the meeting will be Bank of Japan Governor Haruhiku Kuroda. Investors will look for any clues that he will ramp up monetary easing measures following a recent slowdown in growth.

The BoJ is already pumping $592 billion to $691 billion per year into the economy through QE. But the economy has recently taken a turn south, shrinking 1.7 percent in the second quarter, the worst slump since 2011 after an increase in the nation’s consumption tax. The BOJ has said the impact of the tax hike should be temporary, but it has left the door open for more stimulus.

Any word this week from Kuroda about weakness in Japan’s economy could prompt further yen selling on bets of further easing.

As far as timing, in a research note this week, Citigroup economists led by Willem Buiter said: “We regard the BOJ’s semi-annual forecast update in late-October as a likely trigger for further easing, especially given the prospect that the government will proceed with the second consumption tax hike in 2015.”

The Fed

Much of the dollar’s recent move is attributed to the weakness of its rivals, namely the euro, yen and pound on dovish comments and expectations.

However, in contrast to the euro zone and Japan, data in the U.S. have been surprisingly positive—from manufacturing to jobs to GDP. After the winter freeze, the economy rebounded 4 percent in the second quarter and is currently experiencing its best monthly job creation streak since the mid-1990s.

Read More US jobless claims slide below 300K

However on Wednesday, the dollar’s jump to fresh mulitmonth highs was attributed to the Fed. Minutes from the July policy meeting signaled potential for a sooner-than-expected hike in interest rates.

“Many participants noted that if convergence toward the committee’s objectives occurred more quickly than expected, it might become appropriate to begin removing monetary policy accommodation sooner than they currently anticipated,” according to the minutes.

Still, the view is that Yellen tends to lean dovish. Instead of focusing on economic gains, she leans toward dwelling on the slack in the labor market, including lack of meaningful wage growth or elevated levels of those working part time, to justify keeping rates at rock bottom levels.

But many economists and strategists say that won’t hold the Fed (and the dollar) back when it comes to tightening faster than other major central banks.

“Despite the supposed ‘dovishness’ of Chairwoman Yellen, the Fed continues to taper and to plan for the normalization of policy,” UBS economists led by Maury Harris and Drew Matus wrote this week.

“We believe Yellen’s arguments about labor utilization are arguments for why policy is currently easy, not arguments for why policy should remain easy indefinitely.”

The consensus view is that the Fed will begin raising interest rates in the middle of 2015.

With this view prevailing, the dollar has already started to flex its muscles, but it could be just the beginning.

According to Deutsche Bank’s Ruskin, “The first time that Janet Yellen comes off as much more hawkish than expected, the U.S. dollar will get a serious boost, but [I] doubt Jackson Hole is the time and place for this.”

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