Strong U.S. Data, Yellen Comments Cement December: What's Next?
- This morning has brought on a some strong U.S. data points with Housing Starts printing a blow-out 25.5% number v/s an expectation of 10.8%; and Initial Jobless Claims came-in at the lowest level in over 42 years – 235k v/s an expectation of 256k. And CPI posted the fastest pace of growth since October of 2014. All are big beats, alluding to additional strength in the U.S. economy.
- Dollar strength, at least at this point on the morning, has been held in-check as a potentially larger driver is speaking to markets starting at 10 AM ET; and this is Janet Yellen’s Joint Congressional Testimony. Chair Yellen has already released prepared remarks which she will read to Congress to kick-off the morning; and in those comments she noted that a rate hike is ‘appropriate relatively soon,’ remarking on the potential dangers in waiting.
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As the euphoria in markets after U.S. Elections has begun to settle, attention is now moving back towards the major drivers of interest rates, monetary policy and the Federal Reserve. This morning, Chair Janet Yellen testifies in front of Congress, and these types of events can bring on big moves much as we saw in February of this year when risk aversion was stopped dead in its tracks, reversing into a ‘risk on’ rally that lasted for much of the following four months. Chair Yellen has already released prepared remarks on the morning, and she’ll start her testimony by reading this to the Joint Congressional Committee. After the remarks, she takes questions, and this can often take on a similar tone to the press conferences that the Federal Reserve will host around rate decisions: Chair Yellen will be peppered with questions and her responses can bring on volatility.
February was an excellent example of this when Chair Yellen went through two days of Congressional questioning as part of the Fed’s twice-annual Humphrey Hawkins testimony. On day one of that testimony on February 10th, markets were in a beleaguered state and many fingers as to ‘why’ pointed back at the Fed with their exuberant plans to hike rates a full four times in 2016. As markets were mid-collapse, Chair Yellen was asked of her and the Fed’s opinion on negative interest rates. She responded that the Fed had looked into the matter, and she wasn’t even sure if negative rates would be legal in the United States. This exacerbated risk aversion as it appeared as though the Fed may be running out of tools in the event of another ‘collapse-like’ scenario.
As her testimony began on day 2 (February 11th), markets had continued to sell-off and she was asked the same question regarding negative interest rates and her response was markedly different, in which she said that the Fed wasn’t going to take any options off of the table, including negative interest rates. This was a much more comforting message to markets because it implied a similar ‘whatever it takes’ mantra to monetary policy, similar to what Mario Draghi had done on July 24th of 2012; helping to arrest the threatening declines being seen in the Euro and European Sovereign Bond prices. Since then, Euro bonds have gone on to be some of the most expensive in the world (with some of the lowest yields), and this is even the case for economies struggling with 25%+ unemployment (like Spain), and stock prices have re-ascended to even higher-all-time-highs.
But today brings a markedly different backdrop. Stocks are near all-time-highs, the Fed appears to have open runway to kick up that next hike in a month at the December Fed meeting, and hope is running high after a contentious election in the United States has finally been met with resolution. But there is a risk factor for the Fed, and this is what may lead to some near-term volatility.
In January, Chair Yellen had mentioned the risk of exuberant U.S. Dollar strength, and the fact that should Dollar strength continue unchecked, this would likely impact exporters which could, in-turn, bring pressure into the U.S. economy (this is a downside of globalization). And in a world where most Central Banks are still driving their currencies weaker with continued dovish monetary policy, this could expose the Greenback to further gains, exacerbating this risk that a strong Dollar will make U.S. exports less-attractive.
What to Watch For?
A hike in December is probably fairly priced-in at the moment, as odds for a hike next month have been near-100% for over a few days now. More telling will be Chair Yellen’s take on rate policy for 2017 and 2018, and how/what she might consider as different now with a Donald Trump backdrop for the U.S. economy. Should Chair Yellen signal more confidence in economic growth in the coming years, this could provide additional strength into the Greenback as the ‘reflation’ trade gets further priced-in. But, as mentioned above, this could have consequences: Namely exposing the Greenback as one of the few currencies in the world that might see higher rates, and this could drive additional capital flows into the currency; eventually, hitting exporters.
So, as we’ve become accustomed to, we’re likely going to see Chair Yellen doing a bit of tap-dancing while trying to remain relatively balanced in her comments and responses to questions being fired at her by members of Congress. But if she does tip-off any additional positivity in response to market movements post-Election, this could drive the Dollar further higher.
--- Written by James Stanley, Analyst for DailyFX.com
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