Waiting for Yellen

The Fed's Yellen testifies before the Joint Economic Committee of Congress today. Her comments today were not expected to deviate much in substance from the FOMC's statement last month. While last week's rise in non-farm payrolls was impressive, we argue that the Fed has announced a new reaction function and the employment data is not what it used to be.

By this we mean that as Yellen steered the FOMC away from the 6.5% unemployment threshold, she posited a broader understanding of the labor market. Specifically, in the April report, the fall in the participation rate (which drove the unemployment rate lower), the flat earnings growth, and the increase of part-time worker for economic reasons indicate that the Fed's Chair (and many other Fed officials) will not be swayed that improvement in the labor market has accelerated.

Japan's markets re-opened after a long holiday weekend, and the Nikkei slumped almost 3%, partly in response to the gains in the yen, bolstered softness in US yields and weaker US equities. The dollar approached last month's low near JPY101.35 and, if one thinks that the market has discounted a dovish Yellen and US Treasury yields are also at the lower end of where they are going, then the market may be offering a low risk entry for long dollar-yen positions. A move now back above JPY101.80 would be the first confirmation that a dollar bottom may be being carved out.

We note that the Markit PMI Composite for Japan collapsed to 46.3 in April from 52.8 in March. This is a relatively new series and goes back to May 2011. When it was launched, it was at 46.2. April's reading is the lowest since then. We suspect Japanese officials have largely written off the April-June quarter due to the sales tax increase. The following quarter is likely to be more important from a policy making (both monetary and fiscal policies) point of view.

French and German data were disappointing, but ahead of tomorrow's ECB meeting, the reports are not driving the price action much. The euro is consolidating yesterday's gains that lifted it to almost the year's high set a couple of months ago just below $1.3970.

France's economy, as we have noted, continues to lag behind the not only Germany, but most countries in the region. Today it reported that manufacturing in March fell 0.7%. The Bloomberg consensus expected a 0.1% increase. The broader measure of industrial output fell a similar amount, bring the year-over-year contraction to -0.8% from -0.5% (revised from -0.8%).

Germany is to reported its industrial output figures tomorrow, but today's factory orders data warn of downside risk to the 0.2% consensus. Orders slumped by 2.8% in March. The consensus expected a 0.3% rise. Domestic orders slipped by 0.6% while the shock came from the 4.6% decline in foreign orders. While some observers see this as a sign of the impact of Russian sanctions, we are less sanguine. The drop in foreign orders was largely, though not exclusively, the result of a 9.4% drop in orders from the euro area itself. Orders from outside the euro zone fell 1.7%--soft but not horrible.

Sterling stays within striking distance of the $1.70 psychological level and is consolidating in narrow ranges. The strength of recent data is sparking more debate about the spare capacity and the threat of upward pressure on prices. The BRC's report should help ease concerns a bit ahead of tomorrow's BOE meeting. The BRC reported that shop prices have fallen from the 12th consecutive month, and the -1.4% reading was twice the decline in the market had expected.

The New Zealand dollar is the weakest of the dollar-bloc currencies today. Two factors weighed on the Kiwi and encouraged the market to shrug off Q1 employment data that if anything was a bit stronger than expected. First, milk prices fell again at Fonterra's auction. The 1.1% decline represents the sixth consecutive weekly fall and brings milk prices down by about a fifth this year. Arguably more important, RBNZ Governor Wheeler stepped up his rhetoric about the Kiwi's strength, implicitly threatening intervention. Tellingly, he also warned that the currency's strength would impact the trajectory of policy. The take away is that a June rate hike, which the market has discounted, is not a done deal.