Fri, Jun 02, 2023 @ 21:11 GMT
HomeContributorsFundamental AnalysisYellen Confirms a March Rate Hike, But the Dollar Drifts Lower

Yellen Confirms a March Rate Hike, But the Dollar Drifts Lower

Speaking to the Executives’ Club of Chicago on Friday, Fed Chair Janet Yellen confirmed that the FOMC is likely to raise borrowing costs when it meets next week. Yellen was particularly hawkish, indicating that if at the upcoming meeting the Committee judges that employment and inflation continue to evolve in line with the Fed’s expectations, then an increase in the Federal funds rate would likely be appropriate. Coming on top of similarly optimistic comments from many of her colleagues recently, the Chair’s comments boosted the probability for a March rate hike even further to reach 80%, according to the Fed funds futures. Fed Vice Chair Fischer, who also spoke on Friday, left hints that he may vote for a March hike too. He said that the recent commentary from many FOMC officials is correct, and that he strongly supports it. Nevertheless, despite these hawkish signals from the Fed’s top two policymakers, the dollar drifted lower following their speeches. We think that this may have been a "buy the rumor, sell the fact" reaction, as investors who had already entered USD-long positions on the hawkish chorus from other FOMC members, locked in profits on Yellen’s confirmation. EUR/USD traded higher, breaking above the resistance (now turned into support) barrier of 1.0570 (S1) to stop fractionally below the 1.0630 (R1) hurdle, defined by the peaks of the 27th and 28th of February. In our view, bearing that the pair oscillates between that zone and the key support of 1.0500 (S2) since the 17th of February, the short-term path is sideways. As such, given the rate’s proximity to the upper bound of the range, we see the case for the bears to jump in and drive the action lower, perhaps to test the 1.0570 (S1) level as a support this time. A clear dip below that obstacle could open the way for another test near the key psychological zone of 1.0500 (S2).

Back to the Fed, in our latest reports we indicated that in order for us to reassess our view for the next rate hike to come in June, we would like to see hawkish hints from Yellen and Fischer, as well as a strong employment report for February. Given the undeniably hawkish signals from the two top officials, we switch our view and now consider the March meeting as the most likely candidate for action. However, we would also like to see February’s jobs data, due out on Friday, before we assume that March is a done deal. At this stage, we think that a serious disappointment in the report, particularly in average hourly earnings, is needed to stop the Fed from hiking when it meets next.

In our view, the main reason the FOMC wants to hike in March is not due to strong underlying fundamentals, as the economic outlook has not changed so dramatically from the February meeting, when the Committee appeared hesitant. Instead, the fact that global markets are calm at the moment allows the Fed to proceed without rocking the boat, something hinted by Fed Board Governor Brainard last week. She noted that global "constraints" of the past two years caused by problems from Europe to China are finally easing.

With regards to the dollar, despite the correction lower after Yellen’s comments, we expect the currency to come back under buying interest in the coming days. This is not only due to the prospect of a March rate hike, as that scenario is largely priced in already. We believe that the main factor for USD to outperform may be expectations for faster rate hikes. Yellen suggested that the process of scaling back accommodation in the future will probably not be as slow as it was in 2015 and 2016. We should also bear in mind that in December, only some FOMC members included expectations for greater fiscal policy in the forecasts for the rate path. This suggests that as uncertainty around fiscal policy dissipates, we could see the "dot plot" being revised higher at one of the upcoming meetings, perhaps as early as in March.

RBA policy meeting in focus

During the Asian morning Tuesday, the RBA will announce its rate decision. The forecast is for the Bank to remain on hold, a view we share following strong hints from Governor Lowe recently that the bar for any further easing is high. The Bank has maintained a neutral bias in all of its recent communications, and in its latest policy statement, it even disregarded the softness in Australian data as being transitory. Considering that economic data have been mixed since that gathering, we do not expect the Bank to change its neutral tone. We believe that the Aussie will react positively to another neutral statement, especially after Lowe recently noted that it’s hard to say that the currency is overvalued. However, we would treat any positive reaction in AUD/USD as providing renewed selling opportunities. The latest dollar rally brought the pair below the key support (now turned into resistance) obstacle of 0.7600 (R1), a move that signaled a short-term trend reversal, in our view. We expect sellers to take the reins again soon and aim for 0.7550 (S1), where a dip is possible to set the stage for the 0.7500 (S2) psychological area.

Today’s highlights:

During the European day, the economic calendar is empty, with no major events or indicators due to be released.

From the US, we get factory orders for January, which are expected to have slowed somewhat.

We have only one speaker scheduled for today: Minneapolis Fed President Neel Kashkari.

As for the rest of the week, on Tuesday the Reserve Bank of Australia decision will be in focus, as we outlined above.

OnWednesday, we get China’s trade data for February. In the US, the ADP employment report for February is expected to show that the private sector have added 180k jobs.

On Thursday, the highlight of the day will be the ECB policy decision, followed by a press conference from President Draghi. The forecast is for the Bank to stand pat. We expect President Draghi to maintain a dovish tone, amid non-accelerating underlying inflationary pressures. From China, we get inflation data for February.

On Friday, the US employment report for February will take center stage. Expectations are for a solid report overall, which may seal the deal with regards to March rate hike by the Fed. We also get Canada’s employment data for February, and Norway’s CPI figures for the same month.

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