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    USD: can Yellen get the interest rate train moving?

    This week the focus, aside from Greece and its ongoing bailout saga, will be the bi-annual testimony from the chair of the Federal Reserve, Janet Yellen, to the US Congress. Tuesday’s testimony, which will start at 1000 ET/ 1500 GMT, is likely to garner the most attention, with Wednesday’s testimony more of the same.

    Below are the main things to look out from Yellen’s speeches, and what her comments could mean for markets:

    • The minutes of the January Fed meeting erred on the dovish side. The market will want to find out just how dovish Yellen actually is, and whether she is willing to look through the US’s period of disinflation as a temporary phenomenon.
    • Will the Fed drop the word “patience” in reference to the timing of a potential rate hike, in its next statement in March?
    • Will Yellen drop any hints that a rate hike could be on the way in June – September?

    These are the main market-moving topics that Yellen is likely to be quizzed on. How she responds could be a major driver of the dollar in the coming weeks after the buck’s upward momentum has stalled in February, and the dollar index has been capped at 95.50 since the end of Jan. So what are the chances of her being dovish or hawkish? We take a look below:

    Dovish: The minutes from the January Fed meeting were on the dovish side and Yellen has a history of erring on the side of caution when it comes to monetary policy. A dovish Yellen would likely highlight the risks to deflation and suggest that falling prices could justify a delay to the timing of the Fed’s first rate hike to later this year or early next year.  

    Neutral: While Yellen is known for being dovish, she has also proven herself to be a pragmatist during her time as the Fed chair, and she is unlikely to say that a brief spell in deflation means the US economy is on its knees. We expect her to sound relatively upbeat on the outlook for the economy, even with the slowdown in Q4, and she is likely to remain positive on the outlook for the labour market. While we doubt that Yellen will commit to a particular month when it comes to the first rate hike from the Fed, she may choose to say that a rate hike is on the horizon, although the exact timing will be data dependent.  She may also use this speech as an opportunity to tell the market that one rate hike may not signal the start of a rate hiking cycle, which could temper any dollar upside from her speech.

    Hawkish: If Yellen is hawkish on Tuesday then she may suggest a rate hike is around the corner, and a rate hiking cycle could be on the cards.

    As you can probably tell, in our view, the most likely scenario is where Yellen takes a neutral tone and suggests that we could be getting closer to a rate hike, but it will ultimately be data dependent.

    Dealing with a Republican Congress:

    This will be the first testimony that Yellen has to do in front of a Republican controlled Congress. Since she was nominated for Fed chair by Obama she could find that some of the questioning is hostile. Some Senators may try to test her dovish credentials. Traditionally the Republicans tend to prefer a slightly hawkish monetary policy, thus she may have to endure tough questions on the timing of the first rate hike, and justify why the Fed hasn’t moved already even though the labour market has improved so dramatically.

    Yellen is no doubt preparing for this eventuality, but the fact that Congress is controlled by the Republicans could make her stick firmly to her neutral rhetoric limiting the potential for volatility in the dollar.

    The USD view:

    Please read our other reports for a more thorough USD view HERE, but overall, because we think that Yellen is likely to stick to a neutral stance, this speech could be a non-event for the dollar.

    However, the bigger risk to the greenback could be if Yellen surprises on the hawkish side, as the economic data and the minutes from the January meeting have not prepped the market for this eventuality. If this is the case then we could see a sharp reversal in the USD. EURUSD could break out of its 200-pip range to the downside, the recent low is 1.1098 – the low from 25th Jan. USDJPY is also likely to be sensitive to comments from Yellen. If she surprises on the hawkish side we could see a break above 120.00, towards 121.00 in the medium-term.

    Takeaway:

    • The Fed’s Yellen testifies to Congress this week.
    • Her testimony on Tuesday at 1000 ET/ 1500 GMT could be the one to watch.
    • We expect Yellen to talk about the threat of deflation, alongside the potential timing of the first Fed rate hike.
    • Overall, we expect Yellen to strike a neutral tone.
    • She is unlikely to specify the exact timing of a potential rate hike, but she may say that the environment is more supportive of a rate hike in the coming months.
    • Yellen will have to skilfully navigate some harsh questioning from a Republican Congress.
    • The bigger risk to the dollar could be from a hawkish Yellen, which we do not expect. If she does surprise the market then we could see the dollar rally across the board.

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