The US dollar is consolidating yesterday's dramatic gains against the major foreign currencies. Prior to the outcome of the FOMC meeting, we had accepted that even as the Fed shifted from a threshold approach to forward guidance to a more qualitative approach, the goal of the new chair would be to underscore continuity.
The way we suggested Yellen's performance could be evaluated was by having little change in market expectations for the first rate hike, which previously was in late Q3 or Q4, depending on the instrument one looked at and the interpolation. By that measure, yesterday was a flop.
To be sure, Yellen emphasized that there was no change in the FOMC's policy intentions. Nevertheless, the takeaway was that the FOMC was more hawkish than expected. The market focused on two elements.
First, Fed funds at the end of next year are now seen at 1.0%, up from 0.75% in December 2013, when the last projections were made. Just as importantly, at the end of 2016, Fed funds are seen at 2.25%, up from 1.75%.
Second, the FOMC said that there would be a "considerable period" between the completion of the asset purchases and the first increase in rates. We would file this phraseology under "strategic ambiguity". However, when pressed, Yellen opined that a "considerable period" could be around six months.
Participants quickly did the math. It anticipates the FOMC completing the asset purchases in October. Yellen's clarification/expansion points to a hike as early as Q2 15. It would not be surprising if in subsequent commentary, the Fed's leadership tries to backtrack from those implications. We expect the first hike to be in late Q3 or Q4 2015.
However, it may be hard to put the proverbial toothpaste back in the tube, especially if the economic data bounces back as the weather impact fades. Moreover, there may be more lasting damage to the Fed's credibility. Under Bernanke, the Fed had developed another tool to help manage expectations. It was individual (but not by name) forecasts for GDP, core inflation, unemployment and anticipated Fed funds rate. Yellen attempted to play down the hawkish results of what she called the "dot plot".
Recall our reservations. We had argued that if Obama and Bernanke wanted to ensure Yellen was a weak leader they would 1) make it clear she was not the first choice; 2) have Bernanke announce the tapering and exit strategy from QE; 3) name a vice chairman who is bound to overshadow her; and 4) have Bernanke stay until the very end, although Yellen was confirmed in early January. Of course, they did precisely this and it serves as a backdrop for yesterday's debacle.
We also recognized that despite some perceptions to the contrary, Yellen is not really a super-dove as she is often portrayed. We perceive her as an independent and pragmatic leader. We also recognized that the Fed presidents rotating to voting positions on the FOMC cast it in a somewhat more hawkish direction. That said, we suspect when the new nominees are confirmed, the next forecasts (June) will include a softening of yesterday's apparent signal.
In addition to the FOMC, developments in China remain a major focus for the markets. For the second consecutive session, the dollar rose more than 1% above the PBOC's yuan fix. The greenback traded a little above CNY6.23, for a new 12-month high. While some observers have placed a greater deal of emphasis on the CNY6.20 level as triggering large scale losses on highly leveraged investment instruments, our understanding is that it is more dynamic and the pressure has been increasing since CNY6.15.
While some US/Europe-based hedge funds are thought to be involved, our understanding is that these positions are primarily held by domestic investors, not foreign. If Chinese officials wanted to continue to wash out the speculative positioning and moral hazard, we suspect that the dollar needs to rise through CNY6.30.
Many economists have revised down their GDP forecasts for the world's second largest economy. The mettle of Chinese officials and the extent of their willingness to emphasize the quality of growth rather than the quantity are being tested and they appeared to have blinked. Chinese officials announced they would expedite construction and infrastructure projects that had already been approved.
Given the restrictions on foreign investors’ access to mainland equities (A-shares), many take exposure through the Hong Kong Enterprise Index (H-shares), which tracks Chinese companies trading in Hong Kong. With today’s 1.7% decline, the index has now surpassed a 20% decline from last December's high. While some argue this is a sign of a bear market, we note that the real high was recorded not in late 2013, but back in late 2010. Even with the latest declines, this index is still about 6.4% above last year's lows. We cite this not a as a bullish sign, but simply to put the recent losses in perspective.
The rise in US yields weighed helped lift the dollar against the yen. The weaker yen did not spill over and help the Nikkei, as appears to be often the case. The Nikkei fell 1.7%. The dollar faces technical resistance in the JPY102.50-80 area.
While the dollar is consolidating yesterday's gains against the yen, it is extending its gains against the euro in the European morning. The euro is falling through its 20-day moving average (~$1.3815) and slipped through the $1.3800 level. This was the top of the 5-cent, 5-month trading range that was broken when the ECB refused to adjust policy earlier this month.
The Draghi-rally began in the $1.3730-50 area and this would be a test of the resolve of the euro bulls. The retracement objectives of the euro's rally off the year's low (Feb 3 ~$1.3477) are found near $1.3780 and then $1.3720.
The US reports weekly initial jobless claims, the March Philadelphia Fed survey and Feb existing home sales. Of the three, we suspect the Philly Fed survey is the most important for market psychology. An improvement here would, like the Empire State survey, strengthen ideas that the weather was an important, even if not only, economic headwind at the start of the year.
Also, with the money supply figures after the markets close, the Fed will also report on its custody holdings. Recall last week, on a Wednesday-to-Wednesday basis (as opposed to a weekly average) the Fed's custody holdings of Treasuries for foreign central banks fell by about $105 bln. This outsized drop, a record, still appears to have been a shift away from the Fed's custody services, but probably not a sale.
The Canadian dollar is the weakest of the majors over the past five sessions, losing about a 1.6% against the greenback and is at new 4.5 year highs. The seemingly hawkishness of the Fed and the seemingly dovishness of the Bank of Canada has taken a toll. On Friday, Canada reports retail sales and CPI figures. We had expected the Canadian dollar to sell off in response to what is anticipated to be soft inflation figures, which the central bank is particularly sensitive to. However, there is risk of sell the rumor and buy the fact type of activity. That said, previous resistance (~CAD1.12) now may act as support.