Did Janet Yellen Kill the Dollar Rally?
BK ASSET MANAGEMENT. The Federal Reserve is in no rush to raise interest rates according to Janet Yellen’s semi-annual testimony on the economy and monetary policy. While the central bank governor expressed optimism about the economic outlook and inflation, she provided no signal on when interest rates would rise.
As a result, forex traders were sorely disappointed but equity and Treasury traders celebrated by sending stocks to record levels and Treasury prices higher. Going into today’s speech, dollars bulls hoped that Yellen would outline a clear path and time frame for tightening but the head of the Federal Reserve opted for flexibility over clarity. According to Yellen, rates could rise at any time but that may not be in next couple of months. When the Fed is ready to raise interest rates, they will change their forward guidance, preparing the market for the imminent move. By keeping the word “patient” in the monetary policy statement, the Fed is telling us that liftoff will not happen for at two more meetings. So when the central bank is ready to move on rates, their first step will be to drop the word “patient” from the FOMC statement. The decline in the dollar against the euro, Japanese Yen and other major currencies today indicates that dollar bulls hoped for more but at the end of the day, we still believe that buying dollars is the right trade because a 2015 rate hike remains on the table.
GDP growth is strong enough to gradually lower the jobless rate according to Yellen and lower oil prices are a significant net plus for the U.S. economy. While China could slow more and the euro area faces risks, the risks are not just on the downside. Inflation could fall further in the near term but should gradually rise back to 2%. The Fed would like to see stronger wage growth but continued strength on jobs should help to lift wages. The central bank doesn’t want to raise interest rates too quickly because they fear that a premature increase would undermine the recovery and hamper job healing. This confirms our view that a June rate hike is unrealistic but in the summer, the Fed could drop the word patient from their statement, paving the way for higher rates in September. We firmly believe that the Fed will change forward guidance at a meeting with a press conference. There are only four of these per year and March is too soon for the change, making June the best option. Market expectations had gotten ahead of themselves in recent weeks with many investors hoping for a rate hike in June so the decline in the dollar today and the drop in U.S. yields reflects a much-needed adjustment. With this in mind we believe that traders should have the opportunity to reestablish USD/JPY long positions near 118.25.