Press Release: US Dollar Expected to Rise as Fed QE3 Hopes Fizzle at Jackson Hole

The US Dollar is likely to rise as Fed Chairman Bernanke withholds a clear signal of forthcoming stimulus at the highly anticipated Jackson Hole Symposium.

Talking Points

• US Dollar to Rise as Fed’s Bernanke Disappoints Hopes for QE3 Signal
• Yen Bought on Haven Demand as Asian Stocks Slump on Japanese Data

The US Dollar was little changed against its top counterparts in overnight trade as traders waited for Fed Chairman Ben Bernanke’s highly anticipated speech from at the Jackson Hole symposium. Traders hope the central bank chief will signal the intention of launching a third round of quantitative easing (QE3). The Japanese Yen outperformed as Asian stocks declined, boosting demand for the regional safe-haven currency. The MSCI Asia Pacific regional equity index fell 0.4 percent after Japan’s Industrial Production figures unexpectedly showed output shrank in July and Augusts’ Manufacturing PMI gauge showed the factory sector shrank at the fastest pace in 16 months.

The doves appear set for a disappointment, with an unequivocal nod toward QE3 unlikely to materialize.Core PCE inflation – the Fed’s preferred measure of price growth – sits well above levels that pushed policymakers into deflation-fighting mode at the onset of QE1 and QE2. Medium-term inflation expectationsalso appear reasonably anchored having crept higher over recent weeks from worrisome levels in early June. Funding conditions have likewise noticeably improved. The Bloomberg US Financial Conditions Index has recovered to levels unseen since the immediate aftermath of QE2 and bond yields are near record lows. US economic data has also performed increasingly better relative to expectations.

Taken together, this suggests the Fed is likely to reserve QE3 for the possibility thatEurozone debt crisis triggers another market-wide credit crunch akin to the aftermath Lehman Brothers’ bankruptcy of in 2008. The rapid approach of the so-called “fiscal cliff” likewise presents a possible scenario where another balance sheet expansion may be needed if US officials allow a jolt of arbitrary austerity to bludgeon the fragile recovery. On balance, the absence of clear guidance on forthcoming easing at Jackson Hole stands to weigh on risk appetite, boosting the US Dollar at the expense of stocks-linked currencies. The greenback may likewise score gains against the Yen, where prices remain anchored to US Treasury yields.

Asia Session: What Happened

Euro Session: What to Expect

Critical Levels

— Written by Ilya Spivak, Currency Strategist for Dailyfx.com

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