Last month, Bank of England governor Mark Carney warned the financial markets that rates in the UK could be increased sooner than the market currently expects. This caused a flurry of activity as investors reacted to the unusual candidness of a major central banker. The pound surged and the interest rate market is now looking for the first rate hike from the BOE at the end of 2014/ start of 2015.
A few weeks ago no one expected Fed chairwoman Janet Yellen to follow Carney down the same path, but today, during her semi-annual testimony to Congress, she has come quite close to pulling a Carney, which has lifted the greenback and weighed on stock markets.
Yellen’s subtle shift to neutral territory:
Yellen has delivered a far more nuanced and balanced message to Congress compared to her last post-FOMC press conference when she called the recent rise in inflation “noise”. The highlights from her speech and Q&A with Senators include:
- • The jobs market has registered notable developments.
- • If the labour market continues to improve more quickly than anticipated… then increases in the federal funds rate target would likely occur sooner and be more rapid than currently envisioned. (This is particularly Carney-esque).
- • She sounded concerned about valuations in some of the riskier sections of financial markets including social media and biotech stocks and lower-rated corporate debt.
- • Her overall assessment on the economy was that it was making progress, even if there is some slack in the labour market, as evinced by stubbornly low wage growth.
Ahead of her speech, the market expected more of the same from dovish Janet. However, this performance suggests Yellen may be more neutral than the market thought.
Whereas at her press conference in June, Yellen said that rates would only rise at a faster pace than currently anticipated if there was an improvement in the jobs market outlook, her comments today suggest that if current levels of job creation can be maintained then the Fed may raise rates sooner than August 2015.
That is when the market expected the Fed to riase rates as of last night. We expect the overnight index market to re-price the risk of a rate hike in the 1H 2015 on the back of this speech.
The two things that could have a long-term impact on financial markets include:
- Her concern about the negative impact excess liquidity can have on the market
- After 5 months of consecutive +200k monthly job growth the Fed seems more confident on the outlook for the labour market, and if this continues then the Fed may consider earlier rate hikes.
Although Yellen hedged her bets with caveats to the economic outlook, it seems like more accommodative action is off the table at the FOMC, unless there is some sort of economic disaster, so the focus is likely to shift to an exit strategy.
Yellen was clear that no decisions have been made on the precise exit strategy from the Fed’s unprecedented asset purchase programme; however, with tapering expected to be complete in October it can’t be long before these decisions are made. And a Fed with an exit strategy on its mind has big implications for financial markets.
Market impact:
The dollar has had its largest daily move since the 3rd July payrolls report for June, and the US Dollar Index is now above its 200-day sma, which came in at 80.26. If we get a daily close above this level then we could see the start of something interesting for the buck. The USD/CAD has crossed an interesting resistance zone at 1.0750, which opens the way to potential further gains.
Likewise in EUR/USD, if we get a close below 1.3585 – the 61.8% retracement of the mid-June to July 1st recovery – then we could see back to 1.3477 – the lowest level since early February. Treasury yields could also play catch up, so far they have only risen 3 basis points, but a Fed in exit strategy-mode could trigger a larger increase in yields, which could add further fuel to the USD fire.
The dollar and the higher yielders club:
If this does pan out, and the dollar recovery is more than just a splutter as it has been in the aftermath of recent strong labour market reports, then the dollar could join the higher yielders club – which includes AUD, NZD and GBP. This could leave the “low yielders” vulnerable to a stronger dollar including the scandis, EUR and JPY.
For now, we will be keeping a close eye on tonight’s market closes for the key USD pairs to try and see if the dollar is ready for take-off.
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Any references to historical price movements or levels is informational based on our analysis and we do not represent or warrant that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, the author does not guarantee its accuracy or completeness, nor does the author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.