Janet Yellen served up an interesting appearance before Congress this week. Striking a relatively dovish tone, the Fed’s “patient” approach to potential rate hikes means that the FOMC will not be raising interest rates in the next two meetings. However, she appeared to strengthen expectations that a rate hike is increasingly likely in Q3 and all but nailed on for coming sometime during 2015. Yellen remains a steady hand on the tiller but once that word “patient” is removed from the statement, the data dependence will mean that volatility will ramp up once more.
Despite this being seen as a relatively dovish display, the market has begun to back a stronger dollar. The trigger remarkably came despite the US dipping into deflation for the first time since 2009. In fact, the headline figure may have dropped to -0.1%, however once the volatile food and energy components are removed, the “core inflation” remained stable at +1.6%. Yellen continues to admit that rate hikes will be on the agenda once the Fed sees inflation on a stead path back towards its 2.0% target. The employment portion of the Fed’s dual mandate remains well on track (amidst a “strong” labor market), and now the committee just needs to see inflation rising back towards target. The data dependence trading may have already begun.
Looking at the dollar major forex pairs, there was a significant turnaround in sentiment on Thursday. Technically speaking, there was a series of key one day reversals which suggest that the dollar bulls are beginning to fight back after a period of indecision on the forex markets. We have seen bearish key one day reversals on Cable, Aussie/Dollar, whilst the euro fell significantly for its first real day of decisive direction for the first time in weeks. We also saw bullish outside days on USD/CAD and USD/CHF. Furthermore, after weeks of consolidation, the Dollar Index made a move to a 4 week high. (There was also a bullish outside day on the US 10 year Treasury yield as the bond markets looked to back the move for a stronger dollar too).
There is much work that still needs to be done to convince that this move is to be decisive and the beginning of a new bull run. There has been an element of retracement so far today on many of these pairs, however the move that we saw yesterday after the inflation data was strong. Even if this is not to be the breakout to be backed, it suggests that strong data will now be backed by the market and the dollar bulls are waiting in the wings to make their next move.
According to the CME Group FedWatch, the Fed Funds interest rate futures suggest that there is around a 53% probability of a rate hike in the mid-September meeting (which is up from a 45% probability just a month ago). This probability of a rate hike rises to 73% at the late October meeting. This all rises to 83% by the mid-December meeting.
It is not going to be a case of “if” the dollar is going to rally, only “when”.