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Daily Commentary 25/02/15

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• Market takes Yellen’s comments as dovish = USD-negative The FT headlined that “Fed paves the way to raise rates this year as US economy strengthens.” The New York Times said “Fed’s Janet Yellen, in Testimony, Counsels Patience on Interest Rate Increase.” Which is it? Perhaps the conflicting headlines reflect the relatively balanced outlook that Fed Chair Janet Yellen presented. In any case, after an initial burst, the market decided that the NYT’s interpretation was more accurate. Fed funds rate expectations fell a large 11 bps in the long end and 10-year bond yields fell 6 bps (13 bps from their peak) to back below 2.0% as the market pushed back expectations of when the Fed might tighten.

• The key points were that she repeated that the “patient” terminology “means that the Committee considers it unlikely that economic conditions will warrant an increase in the target range for the federal funds rate for at least the next couple of FOMC meetings” and that they would drop the “patient” phrase before raising rates. Concretely, this means at the earliest they could drop the phrase at the March meeting and start raising rates in June. At the same time she emphasized that dropping the “patient” phrase does not mean that they will necessarily start raising rates “in a couple of meetings,” but rather just “that conditions have improved to the point where it will soon be the case that a change in the target range could be warranted at any meeting.” In other words, after they drop the “patient” phrase, then we are back to watching the data and deciding meeting-by-meeting. This important phrase was seen as diluting the forward guidance somewhat and caused the change in view on interest rates. Moreover, Yellen also emphasized that the continued low level of inflation might still push back the timing of the liftoff, and she said that they were looking at all measures of inflation, including food and energy, not just core PCE. Thus the dovish interpretation.

• At the end of the day, the bond market seemed more interested in the testimony than the FX market. The day’s 0.61% range on EURUSD was below the average 0.83% range for the last six months, while the 0.93% range in USDJPY was exactly average. So no big fireworks. The main movements were in CAD, NZD and AUD, but for other reasons – see below. Nonetheless, I think the testimony could dampen demand for the dollar somewhat. True, the US and UK remain the only major countries where a rate hike is being contemplated, but clearly a lot now depends on inflation, and the global trend is for inflation to remain soft. So while I think USD is still on an uptrend, it may not rise as quickly as I had expected, unless US wages start to rise significantly. In that respect, the recent move by Walmart to raise wages could be even more important than Yellen’s testimony.

• Read the text at www.federalreserve.gov/newsevents/testimony/yellen20150224a.htm

• Poloz sends rate expectations plunging Bank of Canada Gov. Stephen Poloz also spoke yesterday and he was definitely dovish. He said the BoC’s surprise cut in rates last month has bought the central bank some time to see how the economy develops. This caused investors to back off from their assumption that BoC might cut rates again at the March 4th meeting, and CAD strengthened as a result. While the timing of the next cut was pushed back, the market is still assuming that the next move in Canadian rates is another cut – something Poloz confirmed by saying that BoC still has “more firepower” — and so I expect CAD to remain under pressure, especially as oil prices remain under pressure too.

• Eurozone accepts Greece’s proposals The Eurozone finance ministers accepted Greece’s reform proposals, which now go to the various national parliaments for approval. This is likely. However, the ministers warned that Greece may be too optimistic about how quickly it can boost tax revenues. The Greek government now faces the difficult task of negotiating those tax increases, which might make some voters wonder just what kind of a “victory” their new government achieved in its negotiations with the troika – now known as the “institutions.” Moreover, there is still some uncertainty over the government’s cash position, which the press says will be exhausted in a few weeks. Greece may fade from the headlines for now but we certainly haven’t heard the last of it as a market factor.

• China’s preliminary HSBC/Markit PMI for February bounced back to 50.1, just above the boom-or-bust line of 50. This caused a jump in AUD and NZD when it came out. However, the figure may have been distorted by the Chinese New Year. With domestic activity sluggish and external demand uncertain, I question how far the measure can rebound and therefore how much support the commodity currencies are likely to get from this source. As mentioned yesterday, the Baltic Dry Index suggests demand for commodities is quite low at this time.

• Today’s highlights: During the European day, we get France consumer confidence for February. In Sweden, Riksbank publishes the minutes from its February policy meeting where it decided to cut the repo rate by 10 bps to -0.10%, adjust the repo-rate path down a bit and to introduce a “mini-QE” to make monetary policy more expansionary. Given the fact that the Bank can unexpectedly introduce further easing measures at any time, SEK is likely to remain under selling pressure.

• In Norway, AKU unemployment rate for December is expected to remain unchanged from the previous month, compared to the increase in the official unemployment rate for the same month. Therefore, we could see an increase in the AKU unemployment rate as well that could weaken NOK somewhat.

• In the US, Yellen testifies again, this time to the House of Representatives. It will be the same speech as on Tuesday, thus the focus will be on the questions. As for the indicators, new home sales for January are coming out.

• In New Zealand, trade deficit is expected to remain more or less at the same levels.

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