Yellen Lifts Dollar

The Fed's Chair seemed to have surprised the market with her comments after North American markets closed yesterday.  She reiterated what the Fed said last week.  It is still on the path to hike rates before the end of the year, barring a significant economic surprise.  She did put the concerns about the global environment in a larger perspective, suggesting that, based on current information, if does not look like developments abroad will have a material impact on policy.  

At last week's FOMC meeting, 13 of 17 officials agreed that it would still be appropriate to hike rate this year.   We think that many participants, disappointed with the lack of Fed action, read the FOMC statement too dovishly.  We think there are compelling parallels between how the Fed conducted the tapering and how it is preparing the market for lift-off.   Many expected the Fed to begin tapering in September 2013.  Instead, it waited for December (despite year-end liquidity issues, which some have argued makes a year-end lift-off more problematic).   The Fed's inaction in September 2013 also initially confused market participants. 

The euro had approached $1.13 yesterday, and Yellen's comments spurred losses to almost $1.1115.  The week's low was set at $1.1105 on Wednesday, just above a key technical level near $1.1080.   Initial resistance now is seen in the $1.1180 area. 

The dollar has gained against the yen as much as it has gained against the euro.  They are tied for the weakest currencies on the day as the North American session is about to begin, Both off about 0.7%.  The yen was also weighed down by the negative core August CPI readings.  Although many expect the BOJ to expand its unconventional easing by the end of next month, BOJ's Kuroda continues to seem in no particular hurry.  He noted that excluding energy, Japan's CPI is near 1.0%.  

The dollar has been tracing out a large triangle pattern since the late-September.  This pattern is usually (75%)  a continuation pattern, which, in this case, means a weaker dollar.  However, we have suggested that fundamental considerations may favor the one in four chance of this being a reversal pattern.  Yesterday, the dollar tested the bottom of the triangle near JPY119.20.   With the help of Yellen and the return to deflation in Japan sent the dollar through the top of the triangle today which comes in today near JPY120.65.  It briefly poked through JPY121.10, which is the highest since September 10.  The high may be in place for the day.  The key will be the close for confirmation of the technical break.  

Beside Japan's CPI figures, the other economic report to note is the eurozone's money supply.   It unexpectedly slowed to a 4.8% year-over-year pace.  The consensus had expected a steady 5.3% pace.  Instead it slowed to its weakest pace since March.  We would not make to big of a deal about this.  It appears to be linked to the slide in equities and liquidity preference.  From the ECB's point of view, the fact that private sector lending held up is more important.  Lending to households rose 1.0% from 0.9%, and to non-financial corporations, 0.4% from 0.3%. 

The comments from ECB officials this week, including Draghi, is that while the asset purchases program can be adjusted in terms of composition, pace and length of the program, more information is needed.   This is essentially what Draghi said at his press conference earlier this month when the ECB did not alter is QE.  However, the ECB staff did cut its inflation and growth forecasts.  Ever central bank that has gone down the QE route has had to do more than one round.    Is the ECB going to be the exception? 

Ahead of the weekend, the US reports revision to Q2 GDP.  While the overall pace of growth (3.7% annualized), the composition may shift a bit toward domestic demand.  Markit releases its preliminary services and composite PMI.  The time series is too short for the market to put much weight on it.  The University of Michigan survey may be of some interest, especially the inflation expectations component, which will likely remain "anchored" a little below 3% for the long-term expectation.   Two hawkish Fed officials speak (Bullard and George) but Yellen has stolen much of the thunder.  

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