Yellen Helps the Dollar Extend Streak

Washington, DC - Federal Reserve headquarters close up

  • Although Yellen’s comments were seen as dollar positive, the impact on the outlook for Fed policy did not change very much
  • The US reports January retail sales, CPI, and IP, February Empire Manufacturing index, and December business inventories and TIC data
  • Yellen is delivering the second part of her Congressional testimony
  • Sweden’s Riksbank met and although policy was unchanged, the central bank expressed concern about the krona’s strength
  • South Africa January CPI rose 6.6% y/y vs. 6.7% expected

The dollar is mostly firmer against the majors. The dollar bloc is outperforming, while sterling and Stockie are underperforming. The krona was hurt by Riksbank comments about recent strength. EM currencies are mostly softer. ZAR and TWD are outperforming, while KRW and RON are underperforming. MSCI Asia Pacific was up 0.8%, with the Nikkei rising 1%. MSCI EM is up 0.7%, despite China shares falling 0.4%. Euro Stoxx 600 is up 0.3% near midday, while S&P futures are pointing to a lower open. The 10-year UST yield is up 1 bp at 2.48%. Commodity prices are mixed, with Brent oil down 0.5%, copper up 0.1%, and gold down 0.2%.

The Dollar Index’s ten-day rally was at risk yesterday, but Yellen’s reiteration of the commitment to continue to gradually lift rates helped extend streak to eleven sessions. This surpassed the streak seen around the election (November 7-November 18). With today’s gains, it may draw closer to what appears to be the longest streak, 14 sessions between April 30 and May 17 2012. To put it slightly differently, the Dollar Index has not had a losing session this month.

The equity advance in the US yesterday, despite the firmer rates, has carried over into Asia and Europe. The MSCI Asia Pacific Index rose about 0.8%, led by a 1% rally in the Nikkei and a 1.25% rally in Hong Kong. Mainland shares that trade in Hong Kong continue drive higher. The 1.7% rally today overcomes yesterday’s minor loss (-0.3%) which ended the six-day advance. This year the Hong Kong Enterprise Index is up 11%, with a little less than half being recorded in the last five sessions.

In Europe, the Dow Jones Stoxx 600 overcome initial weakness, perhaps helped by the rally in US shares, and closer higher yesterday. It is adding another 0.4% today to extend the streak to the seventh session. Today’s advance is being led by financials and real estate. It is at its best level since early December 2015.

The US 10-year yield is firm near 2.48%. Most European yields are lower, but Germany is steady. The premiums over Germany continue to drift lower. A notable exception is Greece, where the country reported that the harmonized measure of CPI jumped from 0.3% in December to 1.5% in January. Greece and the official creditors do not appear to be moving closer ahead of next week finance ministers meeting, which is thought to be the last opportunity to strike an agreement before the Dutch parliament is dissolved ahead of next month’s election. Greece does not need to funds until July.

In the foreign exchange market, the dollar’s gains are against Europe and the yen, while the dollar-bloc is firm. The Australian and New Zealand dollars are the only majors up against the greenback while the Canadian dollar’s 0.03% loss (at ~CAD1.3080) puts in in third place. The Australian dollar continues to be pinned in a $0.76-$0.77 range.

Although Yellen’s comments were seen as dollar positive, the impact on the outlook for Fed policy did not change very much. Consider that implied yield of the March Fed funds futures slipped half a basis point to 0.69%. The average effective Fed funds rate is steady at 66 bp presently. The implied yield of the June Fed funds futures contract rose to 0.84% from 0.825% while the implied yield of the December contract roe three basis points to 1.13%.

Turning yields into odds of a hike, Bloomberg’s calculations suggest a 34% chance of a March hike (was 30%) and 73.5% chance of a June move (was 71%). The odds that by the end of the year the Fed would have delivered three hikes this year (lifting the target range to 1.25%-1.50%) is 26.4%, up from 24.4%. The CME’s calculation is less sanguine about the near-term, but converges with the Bloomberg calculation of the odds of three hikes before the end of the year.

Yellen did not seem to break fresh ground yesterday. She stuck close to the FOMC statement in her economic assessment. All meetings are live, including March. If there was something new, it may have been that the Chair did not see using the unwinding of the balance sheet as a policy tool, such as to remove accommodation. We thought that it could indeed be used like that. The time frame is not clear, but it appears discussion of reducing the balance sheet will begin shortly. Many look for an announcement toward the end of the year, with implementation beginning sometime next year.

There are two things to note here. First, the initial steps will likely involve not reinvesting the maturing issues. This has been the basic message for some time. Second, managing this process will likely not be under Yellen’s watch. As we have discussed, the composition of the Board of Governors will change dramatically over the next eighteen months. President Trump will appoint at least three of the seven governors this year and two next year. During the campaign Trump was critical of the low interest rates and accused Yellen (sic) of doing so for political purposes. Many think that as President, Trump will favor easy money, but the institutional mandate of the central bank will not change (unless Congress does so and it would take quite some time).

We note too the bipartisan nature of the Fed. Consider Volcker was appointed initially by Carter and reappointed by Reagan. Greenspan was appointed by Reagan and continued through Clinton. Bernanke was appointed by Bush and reappointed by Obama. This does not mean that Trump will renominate Yellen, but the point is the institutional requirements tend to dampen ideological fervor.

After a quiet few days for key US economic data, the calendar is full today. The US reports January CPI, retail sales and industrial output, and the February Empire survey. The Bloomberg median forecast is for a 0.3% rise in January CPI for a 2.4% year-over-year pace, but for the core rate to slip to 2.1% from 2.2%. We suspect the risk is on the upside.

Retail sales will also be in focus. The 0.6% rise in January will not be repeated, but the GDP component was up 0.2% in December and could improve on that in January. Here we suspect that the markets may be more sensitive to disappointment with consumption than inflation.

The 0.8% rise in December industrial production also most likely was not repeated in January, and a flat reading is expected. Here we suspect the risk is on the upside, perhaps stemming from the energy sector and increasing rig count. Manufacturing is expected to expand by 0.2% matching the December gain. Note that the average monthly change in manufacturing last year was nil. The Empire survey for February is expected to improve slightly (from 6.5 to 7.0), which would be the fourth month with a positive reading. That would be the longest streak since late 2014.

Yellen is delivering the second part of her Congressional testimony. The text is the same; the question will change (though not the answers). Also, after the markets close, the latest Treasury International Capital report (TIC) will be released. Given recent talk that central banks are reducing their holdings, the data may be scrutinized. Note that the Fed’s custody holdings (for foreign central banks) of Treasuries increased by about $55 bln in December (which will be covered by the TIC report later today).

Elsewhere, the most important economic report came from the UK. Although the labor market had appeared to lose some momentum recently, today’s jobs report was a bit better than expected. Jobless fell 7k in Q4 and employment rose by 37k. The claimant rate eased from 2.3% to 2.1%. The claimant count fell a whopping 42.4k in January, following a revised 20.5k fall in December (from an initial estimate of a 10.1k decline). The claimant count has become more volatile due to changes in the Universal Credit benefits, which is impacting the seasonal adjustments.

Disappointment comes from average earnings. Despite what appears to be near full employment, UK wage growth remains lackluster and at risk of being offset in full by rising price pressures. Average wage growth in the three months through December rose 2.6%, unexpectedly weakening from 2.8% overall and 2.7% excluding bonuses.

Sweden’s Riksbank met and although policy was unchanged, the central bank expressed concern about the krona’s strength, which it feared could derail progress toward its inflation target. It not only warned that it maintained an easing bias, but it also threatened to intervene in the foreign exchange market. The market took the comments as a green light to sell the currency and the krona is the weakest of the majors today, off 0.5% against the US dollar and about 0.2% lower against the euro. The euro needs to resurface above SEK9.50 to be important from a technical perspective. It is the upper end of this month’s range. Above there, near-term potential extends toward SEK9.60.

South Africa January CPI rose 6.6% y/y vs. 6.7% expected and 6.8% in December. This is the first deceleration in five months, as the firmer rand is helping to push inflation lower. South Africa also reported December retail sales, which rose only 0.9% y/y vs. 2.2% expected and 3.8% in November. Price pressures remain elevated, but the sluggish economy is likely to keep the SARB on hold for now. Next policy meeting is March 30, no change in rates expected. Indeed, if disinflation continues, we may have seen the end of the tightening cycle.