US Dollar Watchers Get Ready for Janet Yellen, Can She Prop the USD Up?
The USD faces its next big test mid-week when US Federal Reserve Chair Janet Yellen briefs the U.S House and Senate on her organisations stance on monetary policy.
On Wednesday and Thursday Jennet Yellen will stand before the House and Senate Banking Committees and explain to them what the Federal Reserve’s outlook for the U.S economy and monetary policy is.
For currency traders it is her views on the economy which will be of interest, as markets try to hone their expectations of how many times the Fed will raise interest rates in 2016-2017. In December the central bank projected four interest rate hikes, this is almost certainly to have been scaled back.
The views come as we publish two pieces of research that suggest the tide is turning against the US dollar.
1) Morgan Stanley see potential for 8% declines in USD
2) Why the EUR/USD should be at 1.28
A hike in March is all but off the table thanks to the global stock market selling we have witnessed. Yellen and her team will be accutely aware that a rate rise could trigger further ructions in emerging markets and commodity markets.
”The thing which would upset the apple cart the most at this stage would be Yellen telling Congress and Markets that the economy is much stronger than it appears,” says Stephen Gallo, currency analyst with BMO Capital Markets, “a dovish turn by Yellen won’t catch anyone by surprise.”
Lloyd’s FX analyst Richard Wilkin’s sees her following in the footsteps of her deputy Stanley Fisher, who last Monday surprised markets with his cautious views on further interest rate rises, spurred by concerns with growing global volatility.
Indeed, it is a rare thing for Yellen and Fischer not to sing from the same hymn-sheet:
“We feel that she will remain cautious around global risks and non-committal. The position taken by Vice Chair Fischer last week.
“The US rates markets have already reflected this “downgrade” in expectations for another rate hike, but last week we saw the USD capitulate and long positions reduced.”
Therefore, Lloyds agree with BMO – although for different reasons - in seeing a ‘dovish turn’ already priced in and the ‘surprise’ premium resulting from a more positive assessment.
Concern about the Dollar
As far back as December 2015 commentators from Deutsche were warning markets about the possibility of a rising dollar providing a counter-balance to the Fed’s hawkish rate hike intensions and therefore leading to a ‘front-loading’ of hikes in the H1.
Although the likelihood of the 75bps front-load is diminishing, it may have been a prescient call in light of extreme EM currency weakness, the effect of which is now coming into play.
FX analysts Viraj Patel of ING Bank, for example, already sees the overly strong dollar as a key theme:
“It seems that the Fed is becoming a little more concerned about the USD.
“The unexpectedly large falls in the currencies of its key trading partners (Asia, Canada and Mexico) has propelled the Fed’s trade-weighted dollar ever higher.
“This and lower oil prices have the market fearing a dovish turn at the Fed.”
The ING note goes on to describe how this conclusion has led it to revamp its conclusions:
“As a house we are scaling back our Fed tightening forecast (just one this year in September) and no longer see EUR/USD hitting parity.
“Instead 1.05-1.15 looks to be the trading range, with the outside risk of Washington being sucked back into the global currency war later this year.”
‘Hidden strengths’
SEB Bank veers slightly away from the ‘dovish consensus in actually seeing the U.S economy as still in good shape:
“the takeaway here is that the US economy is not falling into recession, far from it in our view.”
Drawing on recent payrolls data they argue that the data shows a ‘drum-tight’ labour market which should now produce upwards pressure on wages:
“While factors such as minimum wages and calendar effects may well have helped pushed average hourly earnings higher in January, the actual 0.5% advance was well-above consensus. This may well be a sign that the drum tight labor market is finally starting to push wage growth higher.”
Nevertheless, despite their upbeat view on the economy which echo’s UniCredit’s positive interpretation of the NFP’s, they don’t see it being enough to push the Fed into a rate hike in March.
“The (Non-Fram Payrolls) report unequivocally supports the Federal Reserve’s (and our) baseline view that further gradual rate hikes are warranted.
“After all, ongoing labor market dynamics are the main driver of consumer spending, which in turn is the main driver of economic growth in the US.”
Q1 Slow-down
The counter argument is provided by Richard Perry of Hantec Markets, who sees U.S growth as slowing down:
“The disappointing ISM data from both Manufacturing and also more importantly Non-Manufacturing suggests that US growth is slowing down in Q1 2016.”
Perry goes on to argue that despite wages “picking up” the Fed is now more concerned with the deflationary effect of a strong dollar, and that this will prevent them from pressing the button in March.
Further:
“..the dollar will continue to come under pressure after the initial payrolls report reaction subsides.”
Perry ends with the forecast that:
“My bearish tendency leaves me to suggest the euro and yen will outperform the dollar in coming months, whilst the commodity currencies will tend to underperform as the oil price remains under pressure.”
