Get Ready for a Jackson Hole Surprise

Expectations are about to change.

At the moment, the futures market is pricing in an 80% chance the FOMC will cut its Fed Funds rate by 25 basis points following its meeting on September 17.

Most folks expect Jerome Powell will hint towards that possibility during his speech in Jackson Hole today.

But, the setup in the dollar argues differently.

Let me explain…

The level of interest rates is one of the many variables determining the price of one currency versus another. In theory, the higher the interest rate, the higher the currency – and vice versa.

After all, money flows to where it is treated best. So, if the United States offers a higher rate of interest than the European Union, money will flow out of Europe (and out of the Euro) and flow into the United States (and into the dollar).

In reality, it is the expectation of interest rates that determines the direction of money flow.

The financial market is a “discounting mechanism.” Money moves based on what we expect to happen. So, the rise or fall in the dollar happens in advance of the decline or increase in interest rates.

With that in mind, look at this chart of the US Dollar Index …

The dollar peaked in January. It has been in a steady decline ever since then.

Readers may recall that in January, the futures market began pricing in a 100 basis-point decline in the Fed Funds rate this year. While the rate hasn’t come down at all, expectations of a rate cut have crushed the value of the dollar.

The dollar index fell 12% between January and July.

Notice, though, what has happened recently…

After bottoming at 97 in early July, the buck has established a new uptrend. It has made a series of higher highs and higher lows. It is trading above all of its various moving averages. And, those moving averages are now coiled together – building energy to fuel the next big move.

To me, this looks like a very bullish chart setup.

Admittedly, we turned bullish on the buck several weeks ago. So far, the dollar index has only moved slightly higher.

But, that move higher has been despite rising expectations that the Fed will lower interest rates.

That’s not supposed to happen. Somebody is wrong here.

Either the currency traders are wrong and the bullish setup in the dollar will reverse, or, the folks betting on a drop in interest rates are wrong, and the dollar is set to explode higher.

It can go either way. But, my guess – based on the bullish setup in the dollar – is Mr. Powell is going to be a bit more hawkish than expected during his presentation in Jackson Hole today.

Best regards and good trading,

Jeff Clark
Editor, Market Minute