Currency markets take a different view on Yellen testimony to bond markets, seeing early US rate rises as more likely. Wheeler's turn to speak today

By Raiko Shareef

The USD is marginally lower, after Fed Chair Yellen emphasised the FOMC’s flexibility on rate rises.

The NZD is by far the weakest performer on the G10 leader-board, taking its cues from a fall in (surveyed) inflation expectations.

The two key facts that Yellen revealed in her testimony to the Senate Banking Panel this morning are thus:

(1) the FOMC will remove the word ‘patient’ from its policy guidance before the first rate hike, and

(2) once that word is removed, a rate hike could come at any meeting. The latter is new information, since the market had come to believe that its removal would signal that a rate hike was two meeting away.

Yellen sensibly used today’s speaking opportunity to disabuse the market of that notion, and introduce some genuine flexibility on the FOMC’s part. This will also temper the inevitable knee-jerk market meltdown (stocks lower, bonds lower, USD higher) when that word ‘patience’ is removed.

Of course, whether or not this flexibility suggests the first rate hike will come one, two, or three or more meetings after the word’s removal was open to interpretation.

The market reaction implies it believes in a delay more than hastening. In our view, Yellen’s comments on the economy were doggedly neutral, but we concede that the risks are skewed toward the first hike later than June, rather than earlier.

On the labour market, the Chair noted improvements in payrolls growth and the unemployment rate, but highlighted the below-trend level of labour force participation. On inflation, she acknowledged falling price pressures, but revealed that the Fed considers longer-term inflation expectations to have remained relatively stable. On the international front, she noted increased monetary stimulus and lower oil prices counters some of the downside risks.

The bond market quite decisively read this as a sign that rates would be on hold for longer.

Currency markets were significantly more sceptical, perhaps best expressed by EUR/USD’s reaction. From a 1.3425 start, it traded briefly on either side of 1.1300 and 1.350, and has settled at 1.342. In other words, sharply unchanged. The fall in US bond yields has been the primary driver of modest USD weakness, primarily via JPY, which is 0.7% weaker relative to pre-Yellen levels. The AUD has outperformed, helped by a small recovery in oil prices.

Our forecast for the first rate hike remains at June, and we suspect the word ‘patience’ may well be removed on 18 March. We remain constructive on the USD as a whole, but conservatively so.

NZD has been the biggest major-currency loser over the past 24 hours, mostly off the back of a decline in the RBNZ’s inflation expectations survey. The decline in the 2-year-ahead measure, from 2.06% to 1.80%, is patently unsurprising, given the decline in oil prices.

But we suspect, with fuel prices back on the up, these indicators will turn higher into year’s end. But NZD’s tumble shows its sensitivity to downside surprises.

It might receive some support from Fonterra’s payout announcement (due tomorrow between 8am and 9am), but we expect upside to be limited.

Today, we will look out for comments out of RBNZ Governor Wheeler’s testimony to parliamentarians. But given its subject (the Bank’s Annual Report), market sensitive comments seem unlikely.

The HSBC China PMI will be worth watching in our session. Tonight, Yellen embarks on the second-leg of her appointments on Capitol Hill, but with the written testimony likely to be a carbon copy of the one already delivered, we are unlikely to learn much more.

----------------------------------------------------------

To subscribe to our free daily Currency Rate Sheet and News email, enter your email address here.

----------------------------------------------------------