Yellen Lifts the Dollar

Yellen Lifts the Dollar

  • The Fed’s Chair seemed to have surprised the market with her comments after North American markets closed yesterday
  • The dollar has gained against the yen as much as it has gained against the euro
  • Comments from ECB officials this week suggest that while the asset purchases program can be adjusted in terms of composition, pace, and length, more information is needed
  • Japan’s CPI figures and eurozone’s money supply were the main economic reports overnight
  • The Brazilian real will remain at the epicentre of the price action in EM markets

Price action:  The US dollar is broadly firmer against the major currencies.  Sterling is outperforming, while the Norwegian krone and the yen are underperforming.  The euro was unable to hang on to yesterday’s gain and has fallen back below its 200-day MA to trade near $1.1150.  Sterling remains heavy and continues to test support near $1.52.  Dollar/yen is moving higher to test the 200-day MA near 121.  EM currencies are mostly weaker after many staged potentially key reversals yesterday.  RUB, ZAR, and TWD are outperforming while the CEE currencies are underperforming.  MSCI Asia Pacific rose 0.2%, with the Nikkei up 1.8%.  China stocks were lower, with the Shanghai Composite down 1.6% and the Shenzen Composite down 3.4%.  The Dow Jones Euro Stoxx 600 is up nearly 3% around midday, while S&P futures are pointing to a higher open.  The US 10-year yield is up 4 bp to 2.17%, while European bond markets are mostly softer.  Commodity prices are mostly higher, with oil prices up nearly 1%

  • The Fed’s Chair seemed to have surprised the market with her comments after North American markets closed yesterday.  She reiterated what the Fed said last week.  It is still on the path to hike rates before the end of the year, barring a significant economic surprise.  She did put the concerns about the global environment in a larger perspective, suggesting that based on current information, it does not look like developments abroad will have a material impact on policy.
  • At last week’s FOMC meeting, 13 of 17 officials agreed that it would still be appropriate to hike rates this year.  We think that many participants, disappointed with the lack of Fed action, read the FOMC statement too dovish.  We think there are compelling parallels between how the Fed conducted the tapering and how it is preparing the market for lift-off.   Many expected the Fed to begin tapering in September 2013.  Instead, it waited for December (despite year-end liquidity issues, which some have argued makes a year-end lift-off more problematic).  The Fed’s inaction in September 2013 also initially confused market participants.
  • The euro had approached $1.13 yesterday, and Yellen’s comments spurred a loss to almost $1.1115.  The week’s low was set at $1.1105 on Wednesday, just above a key technical level near $1.1080.   Initial resistance now is seen in the $1.1180 area.
  • The dollar has gained against the yen as much as it has gained against the euro.  After the Norwegian krone (-0.9%), the two are tied for the weakest currencies on the day as the North American session is about to begin, with both off about 0.7%.  The yen was also weighed down by the negative core August CPI readings.  Although many expect the BOJ to expand its unconventional easing by the end of next month, BOJ’s Kuroda still seems in no particular hurry.  He noted that excluding energy, Japan’s CPI is near 1.0%.
  • The dollar has been tracing out a large triangle pattern against the yen since late September.  This pattern is usually (75%) a continuation pattern, which, in this case, means a weaker dollar.  However, we have suggested that fundamental considerations may favor the one in four chance of this being a reversal pattern.  Yesterday, the dollar tested the bottom of the triangle near JPY119.20.   With the help of Yellen and the return to deflation in Japan, the dollar went through the top of the triangle today which comes in today near JPY120.65.  It briefly poked through JPY121.10, which is the highest since September 10.  The high may be in place for the day.  The key will be the close for confirmation of the technical break.
  • The comments from ECB officials this week, including Draghi, suggest that while the asset purchases program can be adjusted in terms of composition, pace, and length, more information is needed.  This is essentially what Draghi said at his press conference earlier this month when the ECB did not alter is QE.  However, the ECB staff did cut its inflation and growth forecasts.  Every central bank that has gone down the QE route has had to do more than one round.  Is the ECB going to be the exception?
  • Besides Japan’s CPI figures, the other economic report to note is the eurozone’s money supply.  It unexpectedly slowed to a 4.8% year-over-year pace.  The consensus had expected a steady 5.3% pace.  Instead it slowed to its weakest pace since March.  We would not make too big of a deal about this.  It appears to be linked to the slide in equities and liquidity preference.  From the ECB’s point of view, the fact that private sector lending held up is more important.  Lending to households rose 1.0% from 0.9%, while lending to non-financial corporations rose to 0.4% from 0.3%.
  • Ahead of the weekend, the US reports a revision to Q2 GDP.  While the overall pace of growth (3.7% annualized) is seen unchanged, the composition may shift a bit toward domestic demand.  Markit releases its preliminary services and composite PMI.  The time series is too short for the market to put much weight on it.  The University of Michigan survey may be of some interest, especially the inflation expectations component, which will likely remain “anchored” a little below 3% for the long-term expectation.  Two hawkish Fed officials speak (Bullard and George) but Yellen has stolen much of the thunder.
  • Many EM currencies staged potentially key reversals yesterday.  BRL, MXN, and ZAR (to name a few) made new all-time lows but then revered to end much firmer.  With Yellen bringing Fed lift-off back into focus last night, we suspect that EM will have trouble building on yesterday’s recovery.
  • The Brazilian real will remain at the epicentre of the price action in EM markets. Just to recap, BRL rallied nearly 6%, local rates fell by some 80 bp at some parts of the curve, and CDS spreads narrowed sharply.  The main catalyst of the move seemed to have been comments by central bank president Tombini on his willingness to act in FX markets and reluctance to hike rates further.  We have long regarded him as the closest Brazil has to a macroeconomic anchor, and this is why.  Given a better mood in global financial markets this morning, the rally is likely to continue.  We still didn’t get any fundamental change in the negative picture for Brazil that would convince us that we have reached an inflexion point.  This would almost necessarily have to come from the political sphere, particularly in the form of positive fiscal news.  We think that many Brazilian assets are in overshoot territory, especially local rates (way too much risk premium) and CDS (vs Turkey, for example), and we would look in these markets to express contrarian views when the time has come.  We think FX and equities will remain very volatile and far more susceptible to trends in global markets.
  • Colombia central bank meets and is expected to keep rates steady at 4.5%.  However, the market is split.  Of the 36 analysts polled by Bloomberg, 25 see steady rates and 11 see a 25 bp hike to 4.75%.  CPI rose 4.7% y/y in August, above the 2-4% target and still rising.  The bank moved to a more hawkish stance at its last meeting, and so a hawkish surprise is possible this week.
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