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With Fed officials heading to Jackson Hole, market participants are bracing for turbulence. Despite raising rates with incredible force, US yields remain stubbornly low as markets speculate about rate cuts next year. That’s counterproductive for a central bank still fighting inflation, and if Chair Powell attempts to ‘right the ship’ in his speech on Friday, that could extend the retreat in stock markets but supercharge the dollar. 

Unofficial meeting

Once per year, Fed officials gather at their summer retreat in Jackson Hole, Wyoming for a symposium to discuss monetary policy. This platform has been used in the past to signal significant strategy shifts, so traders view it as an unofficial Fed meeting. The message this year could be a little sobering.

In a nutshell, markets aren’t behaving like the Fed needs them to. Yields on government bonds are simply not high enough to truly slow the economy and fight rampant inflation. As such, inflation expectations have started to creep higher again.

Bond traders are essentially saying the Fed can raise rates all it wants this year, but it will still be cutting them next year to deal with some crisis. This assumption is making the Fed’s job harder. Policymakers might need to raise interest rates even higher to compensate, putting unnecessary pressure on an economy that’s already losing steam according to business surveys.

Shock therapy

The desired outcome for the Fed would be to raise longer-dated yields without causing panic in the markets. One way to accomplish that would be to push back against speculation for rate cuts next year, stressing that rates will need to remain elevated for a prolonged period to bring down inflation, even if the economy stalls.

Another way would be through the balance sheet. The process to reduce the balance sheet has already started and will double in pace next month, with $95 billion in securities rolling off per month as they mature. Any hints that the pace can be ramped up if needed through the active sales of securities could do the trick.

In either case, the dollar would likely benefit. If so, euro/dollar could encounter initial support around 0.9860, a region defined by the lows of December 2002.

Of course the dollar has already come a long way and if Powell isn’t quite so forceful, that might spark a retracement, sending euro/dollar back above parity for a test of 1.0120. That said, any relief rally that stays limited below the trendline drawn from the February highs would keep the pair in a clear downtrend.

No reversals yet

In the big picture, it’s still difficult to call for any trend reversal in the US dollar while the outlook for the rest of the world remains even gloomier. A spiraling energy crisis in Europe has kneecapped heavy industry and consumers, almost ensuring a brutal recession that the European Central Bank cannot deal with because of its inflationary implications.

In Japan, the central bank refuses to even consider tighter policy, keeping the yen under heavy pressure as other nations raise interest rates. Meanwhile, the British pound is trading in lockstep with unsteady stock markets, and the implosion in China’s property sector has ravaged commodity-linked currencies like the Australian dollar.

Therefore, there are no alternatives. And the darker the global outlook becomes, the more safe-haven flows the dollar can attract as traders seek shelter from the storm, even if the US economy is also losing power.

The only catalyst that could truly change this story is a ceasefire in the Ukraine war, which has been raging for six months now. Unfortunately, that doesn’t seem imminent.

Cable is trading near new multi-month low (1.1717) posted today, keeping firm bearish stance, additionally boosted by terrible UK manufacturing PMI data for August that add to fears the economy is sliding into recession.

Bears probed below 2022 low (1.1760) but need a clear break here to confirm a double -top at 1.2293/1.2276 (Aug 1 /10 tops) and resume larger downtrend, though Monday’s failure to close below this level and today’s quick bounce from new low, warn that the action may hold for consolidation before bears regain full control.

Oversold daily studies support the notion, with limited upticks to be ideally capped at 1.1900 zone and keep intact upper breakpoint at 1.20.

Res: 1.1784; 1.1836; 1.1886; 1.1925.
Sup: 1.1717; 1.1700; 1.1634; 1.1556.

The British pound has jumped 0.82% today, as the currency has rebounded somewhat from its worst week of the year. GBP/USD plunged 2.53% last week, as the US dollar has found its mojo after weeks of beating a retreat. GBP/USD has climbed today after US New Home Sales dropped to 511 thousand in July, down from 585 thousand in August and well below expectations.

UK manufacturing slides

The UK Manufacturing PMI crashed into contraction territory in August. The index fell to 46.0, down from 52.1 in July and shy of the estimate of 51.1. The dismal reading is part of a pan-European downward trend in manufacturing, which has been made worse by the prolonged war in Ukraine. Output has been hampered by higher costs, a drop in demand and supply chain problems.

CBI Manufacturing Output fell by 7% in the three months to August, according to the CBI, down from +6% in the three months to July. This was the first decline in output since February 2021. Manufacturers are also affected by rising energy bills and higher interest rates, and the situation is only expected to get worse. The energy cap will rise in October and the BoE will have to continue raising rates in order to defeat inflation.

There was better news from Services PMI, which was almost unchanged at 52.5, pointing to weak expansion (52.6 prior). Still, it’s hard to see how the UK can avoid a recession with weak growth and spiralling inflation. Business optimism is dropping, and that will likely lead to a cutback in spending, hiring and investment, which won’t help the economy one bit.

There is plenty of anticipation ahead of Jerome Powell’s speech at Jackson Hole on Friday, but investors shouldn’t overlook some key events prior to Powell’s speech. Durable goods orders will be published on Wednesday, with the headline reading expected to slow to 0.6% in July, down sharply from 2.0% in June. Thursday brings US GDP for Q2, which is expected to come in at -0.8% QoQ, after a 0.9% reading in the first quarter. With the Fed stating that US data will be critical in determining its rate policy, the dollar could show some movement after these releases, just as it fell sharply today after the soft New Home Sales reading.

GBP/USD Technical

•  GBP/USD faces resistance at 1.1924 and 1.2005
• There is support at 1.1699 and 1.1568

US indices fell rather dramatically in the last two sessions. There were a couple of factors contributing, but the Jackson Hole symposium later in the week is seen as a risk catalyst. But in early trading today, better than expected PMI in Europe helped bring back some risk appetite.

With generalized concerns over the health of the US economy, Durable Goods could prove to be an important point for risk sentiment. Investors and CEOs can talk about where they see the economy going, but it's where they put their money that really counts.

What's a stake

Durable goods are seen as a barometer of expectations of the economy, because they represent large investments that firms expect to recover over a period of several years. They are also typically more discretionary since a company doesn't have to open a new factory as much as it has to buy supplies. Increasing durable goods, therefore, is generally seen as a sign that businesses feel they have enough funds in the short term and expect growth in the medium to long term.

This is particularly relevant in periods of higher interest rates, since a lot of durable goods are bought on credit. With rising interest rates, businesses need a higher rate of return to justify taking out loans to buy more equipment. Consumer sentiment can be a little more fickle, as people respond to headlines. Businesses typically take a more measured and studious approach before spending large amounts of money.

What matters in the data

Some distortion can enter durable goods orders on two fronts, but the most relevant right now is defense. Increased defense spending because of heightened geopolitical tensions can inflate the durable goods orders number. Defense spending is discretionary on the government, so the ex-defense figure typically is what the market focuses on.

Though lately there is more interest in the transportation numbers, because automobile production has been curtailed. But industrial transportation has been increasing. Paccar, for example, reported new truck deliveries up 17% over last year. If the economy is going to recover, and supply chain issues resolved, then more trucks are going to be needed, along with more railcars. On the other hand, economic underperformance could weigh on the sale of aircraft.

What to look out for

Headline July Durable Goods Orders are forecast to slow to 0.6% growth compared to 1.9% prior. This comes in conditions when monthly inflation was reported as flat. Durable goods excluding transportation are expected to have grown 0.2% compared to 0.3% in June. Durable goods excluding defense are expected to come in at 0.3% compared to 0.4% prior.

From the projections, we can see that the largest variable is transportation, with investors expecting firms to have cut back on their spending. This is understandable after major retailers such as Walmart, Target and Home Depot reported having large inventories.

Markets:

The market focus temporary shifted from Fed Powell’s assessment on monetary policy at Friday’s Jackson Hole symposium to the EMU growth outlook. Activity in the EMU as measured by the PMI’s as expected/feared again contracted in August. The composite index dropped further below the 50-reference, easing from 49.9 to 49.2, the weakest level in 18 months. After unexpected resilience in H1, negative growth in Q3 looks ever more unavoidable. Contraction was mainly due to manufacturing activity (49.7), but the post-pandemic rebound in the services sector was also eroded by the negative impact of higher prices on demand (Services PMI at 50.2). Declining demand is weighing on orders causing a build-up in unsold inventories. ‘Concerns over the economic outlook meant that business confidence remained muted in August. This relatively weak sentiment, plus a sustained downturn in customer demand, meant that firms were increasingly reticent to expand staffing levels and the rate of job creation softened to the slowest in almost a year-and-a-half as a result’, the S&P assessment sounded. .Prices pressures remain elevated even as there are tentative signs that inflationary pressure has reached a peak. The PMI’s still painted a worrisome picture on the EMU economic performance, but optimists maybe will retain that the report at least wasn’t worse than expected/feared. (Interest) rate markets showed no clear directional reaction immediately after the PMI release. In the end, the established uptrend in yields simply continued. The German curve bear steepens with yields gaining between 1.5 bps (2-y) and 6 bps (10/30-y). The US yield curve shows a similar move rising up to 6.0+ bps (10-y). UK Gilts are again clear underperformers with yields jumping up to 16 bps (5-y) despite a mixed/unconvincing UK PMI (composite 50.9, but manufacturing tumbling to 46.0) and a poor CBI orders report (cf infra). Equities stayed under pressure for most of the session (Eurostoxx -0.1%, US indices open little changed), but the sell-off is far less aggressive than was the case yesterday. Gas prices (Dutch future reference contract) at € 266/mwh stay near record levels, but at least for now, one can hope for a lower daily close. Oil gains only marginally (brent $97,6/b) even as the Saudi Arabian Energy Minister warned that OPEC could cut production to bring the market ‘in line with fundamentals’.

An ‘in-line’ EMU PMI evidently wasn’t enough to change fortunes for the single currency. EUR/USD (0.995) keeps the established downtrend, even as some relieve kicked in this afternoon. The USD DXY index (109.00) just failed to touch the June top (109.29). Will Fed Chair Powell finally pull the trigger for a new episode in the USD ascent? The sharp rise in UK yields doesn’t change the trading dynamics for sterling. Cable (1.179) is holding near the YTD/cycle low, but the UK currency gains a few more ticks against the euro (EUR/GBP 0.8445)

News Headlines:

The Hungarian government submitted a comprehensive package of more than 10 legal changes to the EU to address all the Commission’s concerns. The EC is withholding around €6bn form the 2014-2020 EU budget and even more pandemic-related payments given concerns over alleged corruption and violations of the rule of law. Part of the funds are lost for good in absence of agreement by the end of the year. The EU stand-off adds to weakness in the local currency. Last week, it was one of the reasons for rating agency S&P to lower the outlook on the Hungarian BBB rating to negative. The forint trades near all-time record lows at EUR/HUF 412. The rising interest rate environment, the proximity to the Russian war in Ukraine and risk aversion in general weigh as well.

The Confederation of British Industry (CBI) published its monthly survey. It confirmed the grim picture of deteriorating growth and accelerating inflation. The total orders component fell from 8 to -7, the lowest level since August 2021. Finished stocks rose from -7 to 2. The inventory build-up was visible in today’s PMI’s as well. Effective output volumes for the next three months fell from 6 to -2. Average selling prices rose from 48 to 57, ending a two-month decline.

US PMI Manufacturing dropped from 52.2. to 51.3 in August, a 25-month low. PMI Services dropped from 47.3 to 44.1, a 27-month low. PMI Composite output dropped from 47.7 to 45.0, a 27-month low.

Siân Jones, Senior Economist at S&P Global Market Intelligence said:

"August flash PMI data signalled further disconcerting signs for the health of the US private sector. Demand conditions were dampened again, sparked by the impact of interest rate hikes and strong inflationary pressures on customer spending, which weighed on activity. Gathering clouds spread across the private sector as services new orders returned to contractionary territory, mirroring the subdued demand conditions seen at their manufacturing counterparts. Excluding the period between March and May 2020, the fall in total output was the steepest seen since the series began nearly 13 years ago.

"Lower new order inflows and continued efforts to rein in spending led to the slowest uptick in employment for almost a year. Reports of challenges finding suitable candidates started to be countered by those companies noting that voluntary leavers would not be replaced with any immediacy due to uncertainty regarding demand over the coming months.

"One area of reprieve for firms came in the form of a further softening in inflationary pressures. Input prices and output charges rose at the slowest rates for a year-and-a-half amid reports that some key component costs had fallen. Although pointing to an ongoing movement away from price peaks, increases in costs and charges remained historically robust. At the same time, delivery times lengthened at the slowest pace since October 2020, albeit still sharply, allowing more firms to work through backlogs."

Full release here.

Daily Pivots: (S1) 136.89; (P) 137.27; (R1) 137.84; More...

Further rise is expected in USD/JPY despite loss of upside momentum. Rise from 130.38 would target a test on 139.37 high. Strong resistance could be seen from 139.37 high to bring another fall from to extend the corrective pattern from there. On the downside below 134.61 minor support will turn intraday bias back to the downside for 131.72 support.

In the bigger picture, price actions from 139.37 medium term top are seen as a corrective pattern to up trend from 101.18 (2020 low). While deeper decline cannot be ruled out, outlook will stays bullish as long as 55 week EMA (now at 123.21) holds. Long term up trend is expected to resume through 139.37 at a later stage, after the correction finishes.

Daily Pivots: (S1) 0.9592; (P) 0.9625; (R1) 0.9677; More...

USD/CHF's rally continues today and the break of 0.9648 resistance argues that whole triangle correction from 1.0063 has completed at 0.9369. Further rise should be seen to 0.9884 resistance next. Break there will argue that larger up trend is ready for resumption through 1.0063. On the downside, below 0.9572 minor support will mix up the outlook and turn intraday bias neutral first.

In the bigger picture, current development suggests that up trend from 0.8756 (2021 low) is still in progress. Sustained break of 1.0063 will target 100% projection of 0.9149 to 1.0063 from 0.9369 at 1.0283, and then 1.0342 (2016 high). For now, this will remain the favored case as long as 0.9369 support holds, even in case of deep pull back.

Daily Pivots: (S1) 1.1726; (P) 1.1782; (R1) 1.1822; More...

Intraday bias in GBP/USD remains on the downside at this point. Current down trend should target 1.1409 long term support. On the upside, above 1.1835 minor resistance will turn intraday bias neutral and bring consolidations. But recovery should be limited well below 1.2292 resistance to bring another decline.

In the bigger picture, fall from 1.4248 (2018 high) could be a leg inside the pattern from 1.1409 (2020 low), or resuming the longer term down trend. Deeper decline is expected as long as 1.2292 resistance holds. Next target is 1.1409 low. However, firm break of 1.2292 will bring stronger rise back to 55 week EMA (now at 1.2859).

Daily Pivots: (S1) 0.9897; (P) 0.9972; (R1) 1.0018; More...

Intraday bias in EUR/USD remains on the downside for the moment. Next target is 61.8% projection of 1.0773 to 0.9951 from 1.0368 at 0.9860. Firm break there should prompt downside acceleration to 100% projection at 0.9546. On the upside, above 1.0045 minor resistance will turn intraday bias neutral and bring consolidations. But recovery should be limited well below 1.0368 resistance to bring fall resumption.

In the bigger picture, down trend from 1.6039 (2008 high) is still in progress. Next target is 100% projection of 1.3993 to 1.0339 from 1.2348 at 0.8694. In any case, outlook will stay bearish as long as 1.0368 resistance holds, in case of strong rebound.