What FX Traders Liked About Yellen's Testimony

What FX Traders Liked About Yellen's Testimony

The intraday recovery in currencies and rally in U.S. equities tell us that forex traders liked what Janet Yellen had to say Friday. Prior to Yellen's speech, nearly all of the major currencies were trading sharply lower against the U.S. dollar due to concerns about the political conflict in the Ukraine and renewed weakness in emerging market currencies. Nothing Janet Yellen said was bearish for the dollar but her acknowledgement of the recent deterioration in data suggests that she could vary the pace of tapering if the softness persists. It would take a "major shift in the outlook" to take the Fed off its course of tapering according to Yellen but in the weeks ahead, the Fed will need to "get a firmer handle on exactly how much of that set of soft data can be explained by weather and what portion, if any, is due to softer outlook." What is important here is that Yellen did not automatically dismiss the data by saying that the disappointments are temporary because the weather is bound to improve. Her openness bolstered risk appetite because it assures a gradual course of tapering by the central bank with the only risk being a smaller and not larger reduction. Nonetheless, her comments that QE will end in the fall is also worth noting because it indicates that for the time being, the Fed doesn't see anything that would change the current pace of tapering. However they are growing increasingly frustrated with tying forward guidance to the unemployment rate. Judging from Yellen's comment that "the unemployment rate is not a sufficient statistic for the state of the labor market. There is no hard and fast rule about what unemployment rate constitutes full employment," there is a good chance the Fed will drop the threshold completely in March. The slide in U.S. Treasury yields, pullback in the dollar and rise in equities are consistent with the view that Yellen's comments pose no major threat to the near term outlook for the economy.

Revisions to Q4 GDP, the Chicago PMI index, pending home sales and final University of Michigan consumer confidence numbers for the month of February are scheduled for release Friday. If GDP growth is revised lower, it could put pressure on the dollar. Thursday's economic reports were mixed. Durable goods orders fell only 1% in the month of January compared to a forecast of -1.7% but what the report was positive for the greenback because excluding transportation orders, durable goods rose 1.1%. After the sharp decline in December, investors were really hoping for a rebound in January and even though there was a large pullback in transportation orders, demand for other goods rose significantly - a sign that confidence could be improving in the economy. The 14k increase in jobless claims is discouraging but not overly concerning because on average, weekly claims have been very low.

EUR Rebounds on Risk Appetite

The euro rebounded against the U.S. dollar Thursday but the move was driven by an improvement in risk appetite during the North American trading session and not Eurozone data. Granted German unemployment and Eurozone confidence numbers surprised to the upside, the downside surprise in Spanish GDP, weaker than expected CPI growth and the ongoing turmoil the Ukraine weighed on the currency during the European session. The greatest risk right now for the euro is the possibility of a rate cut by the ECB next month. Germany is doing well but other countries in the region like Spain are lagging behind. European bond yields are down across the board Thursday with Spanish bond yields dropping to its lowest level since 2006. Some investors say this decline represents an increase in expectations for ECB easing but with an uptick in confidence and rebound in German consumer prices during the month of February, we still feel that the chance of a rate cut next month is low. Political troubles in the Ukraine helped the Swiss Franc shrug off weaker GDP growth in the fourth quarter. The economy grew only 0.2% at the end of the year, driving annualized GDP growth down to 1.7% from 2.1%. Nonetheless as we've seen in price action, risk appetite is the key driver of EUR/USD flows. Consumer spending numbers are scheduled for release from Germany and France Friday. The wide divide between German and French growth should become even more apparent with spending expected to grow in one country and contract in the other.

GBP: More MPC Officials Talk Rate Hikes

With no major U.K. economic reports on the calendar, the British pound ended the day slightly higher against the U.S. dollar and lower versus the euro. The prospect of a large M&A distribution next week continues to keep GBP/USD supported above 1.66. We heard from Bank of England monetary policy committee members Dale and Miles Thursday. Both gentlemen appear to be comfortable with the current level of monetary policy. Like many of his peers, Dale feels that rate increases need to be gradual and will remain below its pre-crisis average for some time. Miles put a hard number around this and said that the "new normal" for U.K. interest rates will be significantly lower than 5%. While there is very little urgency to tighten monetary policy, the fact that U.K. policymakers are talking about how rates should be increased at all is very interesting. They are warming to the idea of reducing stimulus and if all goes well over the next few months could even raise rates at the end of 2014, beginning of 2015. Consumer confidence is scheduled for release this evening followed by Nationwide House Prices Friday morning. We are looking for slightly firmer numbers all around but these releases are not major market movers for sterling.

CAD Accelerates Losses Ahead of GDP

The Canadian dollar traded lower against the greenback for the third consecutive trading day. Lower oil prices, risk aversion and concerns about growth in Canada contributed to the rally in USD/CAD. Having erased all of Friday's losses, the currency pair is crawling towards its 4 year high at 1.1225. In order for it to reach that level, we need a major disappointment in Friday's GDP report. According to the consensus forecasts, economists are looking for slightly slower growth in the fourth quarter, driven in part by a contraction in December. Unlike many other countries, Canada is unique in the sense that they release GDP on a monthly and quarterly basis. When both reports are due on the same day, the market over weights the less volatile quarterly release. Given the sharp deterioration in trade and retail sales towards the end of the year, there's a very good chance that both the monthly and quarterly numbers could surprise to the downside, accelerating the losses for the CAD and promoting the rally in USD/CAD. Meanwhile the best-performing currency Thursday was the New Zealand dollar, which rose more than 0.8% versus the dollar. Since the trade numbers were only slightly better than expected and still weaker than the previous month, the main reason for NZD strength is Fonterra's decision to raise milk prices this season. Higher commodity prices increase the revenue for local famers and raise the risk of a rate hike by the RBNZ next month. The Australian dollar on the other hand traded lower after a surprisingly large decline in private capital expenditure -- a key measure of investment. Aside from Canadian GDP, New Zealand business confidence is also scheduled for release.

JPY: Time for Japanese Data Dump

Risk aversion drove the Japanese Yen higher against all of the major currencies Thursday. So far it has been a quiet week in Japan but that could change with Friday's monthly data dump. Japan releases economic data on a regular basis but one Friday every month a number of Tier 1 economic reports are released simultaneously. Friday night we have the manufacturing PMI index, household spending, jobless rate, consumer prices, industrial production and retail sales scheduled for release. Since the recovery slowed towards the end of last year, stronger growth is needed in the first quarter to provide enough of a cushion for the economy when the consumption tax is increased because growth is expected to contract. There will most certainly be improvements in some releases and deterioration in others but among the releases, industrial production is generally the most important because it is a leading indicator of economic activity. Economists are looking for a significant pick up in IP, which would be positive for the Nikkei and USD/JPY. According to last night's Ministry of Finance report, Japanese investors were net buyers of foreign bonds but net sellers of stocks in the week ending on February 21.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.