US Dollar May Find a Lifeline on Day Two of Yellen Testimony

Talking Points:

• Yen gains as Hong Kong, Seoul stocks catch up to global equities rout
• Markets took Yellen comments as dovish despite hints to the contrary
• Second day of testimony offers opportunity for overt rate hike signaling

The anti-risk Japanese Yen outperformed as Asian stocks slumped in overnight trade, fueling the unwinding of carry trades funded in terms of the perennially low-yielding currency. The MSCI Asia Pacific regional benchmark index fell over 1 percent as bourses in Hong Kong and South Korea reopened after the Lunar New Year holiday and moved to catch up with selling seen elsewhere earlier in the week.

Looking ahead, another day of Congressional testimony from Fed Chair Janet Yellen is in focus. Yesterday’s outing before the House Financial Services Committee produced mixed results. The US Dollar fell alongside front-end bond yields while gold prices rallied, suggesting investors interpreted Yellen’s comments as broadly dovish. This failed to inspire a recovery in risk appetite however, with stock prices dropping as sound-bites from the testimony crossed the wires.

This makes for a clouded landscape going forward as Yellen faces another grilling, this time before the Senate Banking Committee. While her prepared remarks should closely mirror those made yesterday, a different set of lawmakers on the offensive may make for a different tone to the Q&A portion of the hearing. This could offer investors fresh leads about the FOMC’s thinking going forward.

For their part, the markets have priced out further rate hikes in 2016. We’ve argued that Yellen will need to be relatively direct in challenging that notion if the FOMC plausibly expects to resume tightening at some point over the next 10 months. Otherwise, vague rhetoric will give room to wishful-thinking investors to find the dovish reassurance they so desperately seek. This would set the stage for a violent readjustment once stimulus withdrawal resumes, an outcome that the Fed would almost certainly prefer to avoid.

Some push-back against dovish excess in the markets’ outlook did emerge. Yellen pointed out that global growth has not dropped off despite recent turmoil in equities argued that the economy appears normal and healthy in many ways. She also repeated the now-familiar refrain that many factors holding down headline inflation are transitory and will fade over time. This clearly proved insufficient to change minds en masse however.

With this in mind, the second day of testimony offers the Fed Chair an opportunity to try again having received the markets’ initial feedback. If yesterday’s short glimpses of a hawkish streak are telling, Yellen may ramp up the rhetoric, pushing the greenback swiftly higher in the process. Alternatively, another timid outing may embolden the doves and compound pressure on the benchmark currency.

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