Forex: US Dollar, Major Currencies Look to Yellen Testimony for Direction

Talking Points:

Empty European Economic Calendar Puts the Spotlight on Yellen Testimony
Aussie and Kiwi Dollars May Advance on Hints of a Fed Guidance Change
US Dollar to Rise if Yellen Favors “Tapering” QE Without Offsetting Policy

An empty European data docket clears the way for the markets to focus on what is arguably this week’s top event risk: Congressional testimony from Fed Chair Janet Yellen. Comments from the newly-minted central bank chief may prove formative for the trajectory of risk sentiment trends and the US Dollar, particularly after last week’s curiously chipper response to a disappointing US jobs report.

US economic news-flow has increasingly disappointed relative to expectations, with the soft nonfarm payrolls print just the latest in a string of underwhelming releases over recent weeks. This coupled with Fed officials’ vocal opposition to slowing the QE “tapering” cycle might have been expected to weigh against risk appetite.

Friday’s price action suggests markets are of a different mind however, with the benchmark S&P 500 stock index erasing fully losses sustained earlier in the week to close in positive territory after the soft jobs data. We see two possible narratives that could begin to help explain this disconnect.

First, the US unemployment rate fell to 6.6 percent in January, putting it within a hair of the Fed’s 6.5 percent guidance threshold. It is possible that investors are hoping that the Fed’scommitment to QE reduction is a change in the stimulus delivery mechanism, not a move away from accommodation. They may thus be hoping that a downward revision in the target jobless rate is ahead.

Alternatively, it is possible that the“anti-risk” theme had simply become over-extended. Indeed, speculative positioning in S&P 500 futures registered at the most net-short in eight months last week. Having put the week’s biggest sources of event risk – the ECB rate decision and the US jobs report – behind them, traders may have seized on a lull in incoming negative news-flow to book profits.

If Yellen’s testimony alludes to the former scenario, risk-geared assets are likely to continue trending higher. In the FX space, this bodes well for the Australian and New Zealand Dollars but may punish the greenback and the Japanese Yen. On the other hand, the absence of a palpable dovish shift in the Fed Chair’s rhetoric may rekindle risk-averse dynamics in play since in mid-January, producing the opposite effect.

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