Yellen hawkishness gives USD a boost
(Peter Rosenstreich, head of market strategy)
USD continues to firm on the back of Fed Chair Yellen’s hawkish comments. The unexpected remarks triggered a rally in short-end yields, supporting USD against low yielding, rate sensitive G10 currencies (JPY and CHF). Expectations for a Fed interest rate hike in March jumped from 35% to 30%. Yellen warned that the US risked a “nasty surprise” if they postponed tightening monetary policy too long. She reiterated her view that if the Fed sits back and then have to race to catch up that this could tip the US into recession. Yellen went on to indicate a “few” (likely signalling three hikes) in 2017 (cycle lasting until the end of 2019). We suspect that the pace of hikes suggested by Yellen is quick given the US economic acceleration in a probable down cycle. However, the unknown is clearly the effect of President Trump. On one hand you have a pro-growth agenda, which would accelerate economic actively and force the Fed to push the brakes. Yet, on the other hand, the brewing trade war between US and China, reinforced by Commerce Secretary nominee Wilbur Ross' anti-china comments to Congress, could easily grind activity to a standstill. We view the potential of a fully-fledged US-China Trade war in 2017 as a real possibility. Ross has promised to push through Trump's protectionist trade agenda and personally has an axe to grind with China after Ross' years of being undercut by the Chinese in steel and coal. In the near term, heading toward the US presidential inauguration with the US rate curve under-pricing and Yellen's additional rate hikes, we anticipate further USD bullish momentums. Long USD against MXN and JPY remain the highest probable trades in our view.
Arnaud Masset, market analyst
Investors reacted sharply to Fed Chair Yellen yesterday as she stated that waiting too long before continuing to rise rates against the backdrop of accelerating inflation could risk a “nasty surprise”. Initially, the US dollar got a solid boost and appreciated against most currencies: 0.60% vs. the EUR, 1% vs. the yen and 0.40% vs. the CHF. As expected, the Mexican peso was the worst performer yesterday with USD/MXN printing at a new historic high of 22.0098 amid the double whammy of Yellen’s speech and Trump’s inauguration tomorrow.
Even though the market is fully aware that inflation could seriously accelerate throughout the year, it also knows that this will highly depend on what Trump delivers. Looking at the behaviour of the foreign market, we note that investors are not fully buying into the Trumpflation story - not to mention that inflation expectations are reversing somewhat.
In such an environment, high quality commodity currencies such as the Aussie and Kiwi are amongst the best performers within the G10 complex. In contrast, market participants seem reluctant to hold emerging market currencies such as the Chilean and Colombian peso, which were down 0.40% and 0.48% respectively yesterday, while in Asia, the Korean won slid 0.92% against the greenback with USD/KRW jumping to 1,177.50. However, the wind has started to change again as investors brace themselves for tomorrow and limit their long USD exposure.
Don’t sleep through ECB
(Peter Rosenstreich, head of market strategy)
The European Central bank will meet today but it is universally expected that no change in policy will result. Yet despite the uneventful expectations there is room for some minor fireworks. December’s meeting resulted in key interest rates remaining unchanged for the sixth consecutive session but asset purchases were reduced to €60 from €80 and extended till March 2017. European economic data has continued to firm, while the political uncertainty emulating from the US has allowed the euro to remain weak further supporting economic expansion. Given the realized macro environment (disconnected form the hype) we have growing expectations for signals of additional policy modification (we consider Dec adjustment to be tightening). Any positive comment on the outlook for inflation such as a steepening trend in wage growth will be euro bullish. Despite the approaching European political drama and Italian risk we feel that the ECB is inching towards signalling the end of unorthodox monetary policy (likely in Sept). In the short term, we are constructive in expectation of a hawkish surprise with EURCHF current recovery bounce extending to 1.07600 and EURJPY to test the range high at 123.75.