Citi: Fed Chair's Jackson Hole Speech Unlikely to Halt Dollar's Decline

Federal Reserve Chair Kevin Warsh's highly anticipated speech at the Jackson Hole symposium is unlikely to halt the U.S. dollar's recent selling pressure, according to an analysis by Citigroup. The bank's strategists argue that risks to their bearish dollar outlook stem more from market valuation and positioning rather than any potential hawkish surprise from the Fed.

Bearish Stance Maintained

Citi has downgraded its forecast for the U.S. dollar from Neutral to Bearish ahead of the central banking conference. Strategists at the bank believe Warsh will likely focus his remarks on medium-term themes, such as productivity and artificial intelligence, which they view as having dovish or disinflationary implications.

Based on this outlook, Citi's real-rate model for the EUR/USD pair points to a target of 1.18. This forecast assumes the Federal Reserve remains on hold while the European Central Bank implements one more rate hike, coupled with a normalization of oil prices.

Hawkish Scenarios Discounted

Citi's analysts outlined three potential scenarios that could prompt a hawkish signal from Chair Warsh, but they conclude that none currently apply.

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• Insufficient rate hikes priced in: The market has already priced in approximately 10 basis points of tightening for the September FOMC meeting. Citi believes this is sufficient from a financial conditions standpoint to satisfy the Fed.
• Need to suppress long-term yields: The bank's rates strategists do not believe that even aggressive rate hikes would successfully reverse the recent rise in the term premium on the long end of the yield curve.
• Re-accelerating inflation: Recent economic data has been "soft on balance," according to the strategists, providing little evidence of a resurgence in inflation that would warrant a more aggressive policy stance.

Positioning and Valuation Risks

While a hawkish policy surprise is seen as improbable, Citi acknowledges other risks to its bearish dollar view. The strategists noted that EUR/USD overvaluation is becoming "more apparent," and with leveraged accounts already positioned short the dollar, some position trimming around the Jackson Hole event is possible.

Geopolitical risks, such as a potential conflict between the U.S. and Iran, are also a factor. However, Citi's team prefers to hedge this risk through options, such as a four-month Norwegian krone vs. Swedish krona call spread, rather than incorporating it into their baseline dollar forecast.