The market staged a dramatic reversal of the near-term trends in response to the Federal Reserve meeting. In a masterstroke, Yellen dropped the word patience from the Fed’s forward guidance and avoided delivering a hawkish signal.
The equity markets bounced back. Bond yields fell. The relentless dollar advance stopped in its tracks. It suffered one of the largest setbacks in nearly a year.
The dollar’s advance accelerated since the end of February. The momentum has surprised everyone. Pullbacks continue to be shallow. The move appears to have taken a life on of its own. Consider last week, as the euro slumped more than 3%, sterling more than 2%, and the dollar-bloc more than 1%, US yields fell sharply.
The strong US employment report offset some of the disappointing data in recent weeks. It reinvigorated confidence that the Federal Reserve will move to raise rates later this year. This coupled with the confirmation of the ECB’s launch of its new bond buying program in the week ahead triggered a resumption of dollar bull market, which a seemingly growing number of participants feared was getting long in the tooth.
The US dollar traded higher against most of the major currencies over the past week. No thanks to Yellen’s testimony before Congress. Market participants took away from her a reduced chance of a mid-year rate hike.
We disagree with the interpretation, seeing her comments as 1) playing down low inflation as transitory and 2) seeing the global influence being overall balanced as the decline in oil prices and interest rates offset the dollar’s appreciation. We continue to expect the FOMC to drop its “patient” forward guidance at its mid-March meeting.
The dollar is consolidating gains scored yesterday, giving it a somewhat heavier tone. Equity markets are trading mixed, consolidating this week’s gains. Bond markets are also mostly quiet.
There are a couple of exceptions. Sweden reported Q4 GDP of 1.1% quarter-over-quarter, which is twice the consensus expectation. The Q3 growth of 0.3% revised higher to 0.5%. The positive momentum spilled over to the January retail sales report, where sales jumped 1.2% fully recouping December’s 0.6% decline.
Sterling and the dollar-bloc currencies firm, but the euro and yen remain confined to well-worn ranges. The US dollar is vulnerable to poor economic news in the form of a negative year-over-year CPI print, especially given no rebuilding of Fed hike expectations in response to Yellen’s testimony.
Anxiety over Greece seemed to offset the dovish read of the FOMC minutes. The US dollar was little higher on the week against both the euro and yen in choppy trading conditions. The much-followed Dollar Index closed marginally higher on the week.
The US dollar’s consolidative phase appears to have ended with the January employment report. Employment growth accelerated, and average hourly earnings rebounded. There was a 10-11 bp increase in both short- and long-term interest rates.
The Federal Reserve’s real broad trade-weighted measure dollar rose 2.1% in January. It is now a little less than 15% above the record low set in July 2011. The chart here shows this measure of the dollar since 2000.
In January, as the (real) trade-weighted dollar rose, US 10-year yields fell 50 bp and oil prices fell by 10%. Surely, the decline in US yields and oil more than offset the economic impact of the dollar’s rise.
The US dollar turned in a mixed performance in the last week of January. It slipped against the euro, yen, sterling and the Swedish krona, while rising against the other G10 currencies. The Swiss franc was the weakest of the majors, losing about 4.5% of its value against the dollar, encouraged by signs the Swiss National Bank may have intervened.
