Yellen 8217 s neutral stance sufficient for dollar bulls

Federal Reserve Chair Yellen’s speech on labour markets at the Jackson Hole Symposium triggered a broad rally in the US dollar as she sounded less dovish (or more balanced) than most market participants had anticipated.

Yellen opened the speech with a typically balanced central bank statement, indicating: “If the improvement in the labour market “continues to be more rapid than anticipated by the Committee or if inflation moves up more rapidly than anticipated” then “increases in the federal funds rate target could come sooner than the Committee currently expects and could be more rapid thereafter.” But Yellen also noted, that if the economy ends up being “disappointing and progress toward our goals proceeds more slowly than we expect, then the future path of interest rates likely would be more accommodative than we currently anticipate.”

Re-defining reaction functions

Market reactions are driven by not only the outcome of a data release, report officials’ remarks, but particularly by the prevailing expectations leading to these events. Thus, none of the above remarks by Yellen would have particularly been hawkish or positive for yields and the US dollar, had it not been for the predominant expectations for a dovish speech. Yellen’s remarks provided a boost for the dollar, without dragging down equities.

Combining Yellen’s neutral disposition and this week’s release of the July FOMC meeting revealing a discussion among members over whether to raise rates earlier than later, the FX markets had little choice but to buy USD.

Let us not forget the recent US economic data, showing three-year highs in the Philadelphia Fed survey, five-year highs in the Markit PMI, a sixth consecutive month of +200k NFP (best showing since 1997), employment participation stabilising at 62.9% (first rise in four months), average hourly earnings showing a y/y rise in five of out of the last seven months and a core PCE price index +1.5% y/y, on track for this year’s uptrend.

FX reaction

And so in order to understand the USD’s reaction to Yellen’s remarks, it is important to grasp the expectations leading to her speech. In fact, we did warn yesterday on Twitter that prevailing expectations for a dovish Yellen may not work out so well (materialise) as the predominant expectations for a hawkish release of Wednesday’s FOMC minutes. Some participants claimed that the dollar rally following Yellen’s speech was mainly a knee-jerk reaction to EU and Ukraine’s statements that Russia’s convoy entering Ukraine was breaking international law. We disagree with those claims because any market reaction from the Ukraine-Russia crisis would have triggered a rally in the yen and Swiss franc and a selloff in equities as was prominently demonstrated following last Friday’s Ukraine attack on Russian convoys. Another point worth pointing out is that the dollar rallied mostly against the lower yielding EUR, CHF and JPY, while commodity currencies such as AUD, NZD and CAD fared less worse. Yellen’s balance stance managed to achieve the feat of propping the dollar, yields and equities, a pure and non-threatening risk rally.