What’ll Yellen’s Testimony Do To The USD?

Will Yellen's Testimony Help or Hurt the Dollar?

Investors were buying U.S. dollars Wednesday ahead of Thursday's testimony from Janet Yellen's on monetary policy. Based on the decline in U.S. Treasury yields and rise in equities investors don't except any particularly damaging comments from the brand new head of the Federal Reserve. We know that she is thinking about changing forward guidance but with 3 more weeks to go before the next FOMC meeting and the release of another non-farm payrolls report, we doubt that she will jump the gun and share her plans on changing monetary policy before the entire committee convenes and discusses their options. Lets not forget that Janet Yellen has yet to chair her first FOMC meeting. She's obviously been intimately involved in past decisions but there's absolutely no benefit to front running the FOMC especially when volatility has declined and stocks are rising. We believe that Yellen's comments will be more beneficial than detrimental to the dollar T. Although new home sales surprised to the upside Wednesday, most of the recent economic reports have been disappointing and some investors are hoping that Yellen will acknowledge the deterioration, using it as a justification for keeping monetary policy easy for a longer period of time. Yet chances are that like many of her peers she will downplay the reports, attributing the weakness to temporary factors and if we are right, the dollar should rally.

It has been only 2 weeks since we last heard from Yellen. She did not say anything new in her semi-annual testimony on the economy and monetary policy. Her promise of continuity and taking "measured steps" in reducing stimulus was well received by the market. She shares Bernanke's optimism about the economy, frustration with the unemployment rate and lack of concern about the swings in emerging markets. Yet Yellen refused to commit to any changes before the next Fed meeting, choosing instead to say there is no preset course for bond purchases and tapering. Changing the unemployment rate threshold remains a possibility in March but as an experienced central banker, she knows there's no benefit to front running the FOMC. Aside from Yellen's testimony at 10am NY Time, durable goods and jobless claims are also scheduled for release T.

EUR Breaks 1.37, Falls to 1 Week Lows

For the past week and a half, most of the major currency pairs have been trapped in narrow ranges and in the case of the EUR/USD volatility is near a 6 year low. This makes the currency pair prime for a breakout and we are already beginning to see an increase in volatility Wednesday with EUR/USD dropping to a 1 week low. Ongoing protests in the Ukraine and a sell-off in emerging market currencies put pressure on the euro along with the surprise increase in U.S. new home sales. The break below 1.37 is significant and leaves the currency pair vulnerable for an extended sell-off down to 1.36. However in order for that to happen, Thursday's German unemployment report needs to be surprise to the downside. Economists are looking for a smaller decline in unemployment but according to the PMIs, February was the strongest month for job growth since January 2012. Aside from the labor market report, German consumer prices and Eurozone confidence numbers are also scheduled for release. CPI is expected to increase sharply in February after falling in January and a rise in price pressures will ease the central bank's concerns about low inflation. On Monday we said that euro would have a positive bias this week and although it has fallen, if German unemployment drops more than expected and CPI rises by 0.6% or better, EUR/USD could resume its rise.

GBP: BoE Policymakers Believe Interest Rate Hikes will be Gradual

Although the British pound traded lower against the U.S. dollar Wednesday, it continues to hold above its key support of 1.66 thanks in large part to the upcoming M&A flows. The U.K. government confirmed that the economy expanded by 0.7% in the fourth quarter. However the details show that private consumption grew less than initially estimated but the slower growth was offset by upward revisions to capital expenditures and exports. Comments from Bank of England monetary policy committee member Miles also put pressure on sterling. He said "people should expect sudden rate increases because there is still quite a lot of slack in the economy." "Next year may be the right time but there is no certainty." As one of the more dovish of the MPC, his cautious comments aren't unusual. However many of his peers also refuse to comment on the timing of tightening. BoE member Dale said he doesn't know when rates will rise but when it happens, it will be gradual. Broadbent agreed that it is difficult to fix the precise point for a rate increase but he is cautiously optimistic about U.K. productivity, which is important because spare capacity is one of the main reasons why the central bank is delaying a rate hike.

NZD: Unimpressive Trade Balance Beat

The New Zealand, Australian and Canadian dollars traded lower against the greenback Wednesday on the back of softer economic data. In New Zealand, the trade surplus declined but less than expected. Economists were looking for the trade deficit to drop to 230M from 523M but instead it printed at 306M. While this may prevent a deeper slide in NZD, the slowdown in export demand will also limit the currency's rise. Meanwhile overnight, Australia reported a 1% decline in construction work. Unfortunately this trend of weakness could continue as mining and housing investment slows. The private capital expenditures report was scheduled for release Wednesday night as a decline in business investment was expected in fourth quarter. The persistent sell-off in the Chinese Yuan could finally be catching up to the AUD. Since Monday we have been singling out the sell-off in the Yuan and talking about how it is negative for Asian currencies. From Canada, we look forward to the Q4 current account balance. After selling off on Monday, USD/CAD resumed its rise and a wider current account deficit could accelerate the pair's gains.

JPY: BoJ Officials Believe in the Recovery

The continued sell-off in U.S. 10 year Treasury yields diminished the positive impact of the rally in U.S. stocks on USD/JPY. In fact none of the Yen crosses ended the day in positive territory despite the demand for equities. No Japanese economic reports were released overnight Tuesday while the only thing on the calendar Wednesday night was the Ministry of Finance's weekly portfolio flow report. On Thursday evening, we'll get a more insight into the performance of the economy with the monthly data dump but between now and then, Yen traders can take comfort in the Bank of Japan's belief that the recovery will remain intact even after the consumption tax hike. According to BoJ monetary policy member Ishida. GDP is expected to contract in the April to June quarter but exports are expected to "become a driver of growth" keeping inflation above 1% as the "supply-demand balance improves." BoJ member Kuroda agrees that "Japan is making steady progress towards achieving 2% price stability" and is "recovering moderately as the effects of QE emerge steadily." Based on these comments, central bank officials don't appear to believe that easier monetary policy is necessary but their bias may change if this week's economic reports surprise to the downside.

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