EUR/USD Exchange Rate Breaks 1.13 as Yellen's Steady Hand is Swept Aside

The euro exchange rate's rise continues with the headline EUR/USD conversion now looking to retake the 1.14 threshold.

The disappointment to US Fed Chair Yellen's appearance before congress was delayed; nevertheless, disappointment is what markets got.

Markets appear to have dismissed assurances they would indeed see further interest rate rises from the US Federal Reserve in 2016 and have continued to sell the dollar. 

"Yellen had to recognise both the underlying strength of the US domestic economy while addressing the potential downside impact of heightened financial market volatility. That’s a tough balancing act to strike when markets are edgy," says a foreign exchange note from ANZ Research.

Expectations that the United States would raise interest rates up to four times in 2016 has been the core underpinning of US dollar strength leading into 2016.

Any suggestion that these rises would not be delivered is therefore understandably negative for the dollar.

The dollar index has closed lower for the 12 of the last 14 days and the EUR to USD conversion continues to relentlessley push higher:

The above chart is decidedly bullish for the EUR/USD and we would expect momentum to continue pushing the rate higher.

In short, we have not heard enough from the Fed to technically alter the underlying market.

We could well see some consolidation though as uncertainty grows as to the next steps to be undertaken by the European Central Bank in light of recent euro strength.

We feel that strength in the euro will ultimately have its limits, but it is worth considering research out of Danske Bank this week that suggests the euro should be at around 1.24-1.28 if fair value were delivered.

Trying to Stay Positive

Having noted the deterioration in global market conditions Chair Yellens’s outlook on the domestic situation was more positive; something that prompted dollar buying. 

The Chair's views on the US labour market and inflation was similar to that expressed in December’s FOMC meeting noting that the labour market continues to make progress, mentioning that there was room for further improvement.

Meanwhile, inflation remains low as a result of further declines in energy prices. Nevertheless, the FOMC  expects inflation to pick up over the medium term.

In her statement she still considers that low oil prices could boost the US economy.

Chair Yellen mentioned that if the domestic economy expands at a moderate pace, supporting employment gains and faster wage growth, then the FOMC still expects gradual adjustments in the stance of monetary policy.

Interest Rate Rise Expectations Downgraded

However, Yellen added several provisos which counter-balanced her central message, adding that she was cognizant of how slowing global growth, tightening financial conditions and a global reassessment of credit risk might potentially “throw the U.S. economy off track from an otherwise solid course.”

Although she said that risks from China and financial conditions were “less supportive” of U.S growth, she did not appear to think this had yet happened and was unequivocal that current global financial turmoil had not yet impacted negatively on U.S economic growth.

Her reiteration that monetary policy was, “not on a pre-set course,” was a still a dovish sign, that the Fed might find it necessary to alter it trajectory at any time if incoming data warranted it.

She was, however, positive about Inflation, saying that: “Many of the pressures holding down inflation are transitory.”

Analysts have downgraded their forecasts for the number of interest rate rises to be announced in 2016, with Yellen's testimony only adding to the trend.

"We do not expect  a rate hike before June, but the focus on financial conditions, suggest that the bar for a rate hike has risen. Other Fed members have also expressed a cautious tone as a result of the turbulence in financial markets, which has escalated since the beginning of the year," says Maritza Cabezas at ABN Amro.

If these developments prove persistent it is unlikely that the US economy will be spared. "This could even delay the next rate hike further than we expect," says Cabezas.