US Dollar "Longs" at Three-year High as Analysts Warn of Reversal ahead of Jackson Hole Symposium

-USD rises but is now at inflection point, positioning at extremes. 

-US-China "trade war", Fed and Jackson Hole in focus this week.

-Analysts are now warning that a USD reversal is in the cards.

© Andrey Popov, Adobe Stock

The US Dollar is now at an inflection point after bets on the greenback reached a near-three year high last week and as markets look to US-China trade talks in Washington and the Jackson Hole symposium later this week for a steer on the likely direction of the currency for the weeks ahead.

US officials will meet their Chinese counterparts Wednesday and Thursday to discuss a series of issues that are at the centre of the so called "trade war" between the world's two largest economies.

Both have been at loggerheads since the US government said the Chinese state is using its might to steal the intellectual property of American companies, as well as other "unfair practices" to get ahead in the international trade arena.

Markets have been on edge because, with each having levied tariffs of up to 25% on more than $250 bn of exports going back and forth between the two countries as a result of the dispute, fears are that the trade conflict will soon weigh on economic growth in China and further afield.

This and superior levels of US growth have helped maintain a bid for the US Dollar, which has risen almost 8% in the last six months, so any signs of a de-escalation between the US and China this week could check the greenback's advance. 

Above: Pound-to-Dollar rate shown at daily intervals.

"Come Thursday, US customs start collecting 25% tariffs on an extra $16bn of Chinese imports, which China has said it will match dollar-for-dollar as Trump ponders whether to proceed with tariffs on another $200bn of goods in coming weeks," says Sue Trinh, head of Asia FX strategy at RBC Capital Markets. "The hope is that the further tariffs can be avoided and the ones implemented to date eventually reversed."

However, concurrently, the market will also be looking to the annual symposium of central bankers that gets underway in Jackson Hole Thursday for direction.

This too will be important for the Dollar and all other currencies. Not least of all because of the stress that a strengthening US Dollar has exerted upon emerging market currencies and economies during recent months.

Markets will be hoping for an acknowledgement of the Federal Reserve's global monetary policy responsibilities, in addition to its own, from Fed chair Jerome Powell. If Powell indulges them then this too could also undermine the Dollar.

Above: Euro-to-Dollar rate shown at daily intervals.

"The question is not only whether the Fed acknowledges the Emerging Market volatility, but also the fact that its own policy signals are playing a part in the broader deterioration in global risk appetite. Under a Yellen Fed, we would be pretty sure that these market conditions would have kept the FOMC in wait-and-see mode. However, Jackson Hole will allow Chair Powell to either reiterate the Fed’s role as the global central bank – or make a marked shift and formally adopt an 'America First' monetary policy approach," says Viraj Patel, an FX strategist at ING Group.

The week's trade and policy events come hard on the heels of Chicago Futures Trading Commission data showing the showing institutional money managers raised their bets on the greenback to a collective $51.2 bn during the week to August 14. This is the largest "US Dollar long" since December 2015 and is close to 100% of the three-year maximum. 

"Leveraged funds’ net position in the USD was long-USD by 30.8bn. That is the biggest net position on either side since December 2015," says Stephen Gallo, European head of FX strategy at BMO Capital Markets. "There has been a USD46bn flip in the leveraged funds USD net position in a 5-month span. The 6% USD rally during that period is a surprisingly small move given the monumental size of the positioning flip."

Above: US Dollar performance against G10 rivals for 2018 year-to-date.

Most analysts now agree the mismatch between economic growth in the US and the rest of the world has created an incentive for traders to sell other developed world currencies and buy US Dollars. This has led the Dollar index to convert what was once a 45 2018 loss into a 4.3% gain. However, with "positioning" now at extremes, analysts are warning of a possible reversal later this week. 

"Long dollar speculative positioning has been building and data released at the end of last week confirmed that this trend of increased long dollar positions has continued. On the two previous occasions positioning has reached these levels, the market has failed to sustain these long dollar positions for very long and were followed by a period of sharp liquidation," says Derek Halpenny, European head of global markets research at MUFG.

Halpenny says a Friday speech from Fed chair Jerome Powell at the Jackson Hole symposium could be the catalyst for a change in fortune for the US Dollar.

"Market participants will be eager to hear more details on the interpretation of the Fed’s most recent comment that further gradual rate hikes were appropriate “for now”. What does “for now” mean and might it imply a possible change in forward guidance? Given our view that USD bullishness has become a little excessive, this speech on Friday could well be a catalyst for a sharp reversal the other way as long dollar positions are pared," Halpenny writes, in a briefing for clients Monday.

The US Dollar index was quoted 0.10% higher at 96.22 during early trading Monday. The Pound-to-Dollar rate was 0.05% higher at 1.2744 and the Euro-to-Dollar rate was 0.12% lower at 1.1421.

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