Yellen on Deck – Will Dollar Turn into a Wreck?

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Market Drivers July 12, 2017
UK Labor data in line
EURUSD hits optionality ahead of 1.1500
Nikkei -0.43% Dax 0.48%
Oil $45/bbl
Gold $1218/oz.

Europe and Asia:
GBP UK Claimant Count 6K vs. 10K
GBP UK Average Wages 1.8% vs. 1.8%
EUR IP 4.0% vs. 3.0%

North America:
USD Yellen Testifies 10:00
CAD BOC Rate Decision 10:00

FX dealing was decidedly more lively on the third trading day of the week, after a marked pick up in volatility in yesterday North American session. With the dollar dented by revelations that Donald Trump Junior may have been compromised by Russian operatives, FX markets continued to push the buck lower, with EURUSD hitting a high of 1.1490 before optionality sent the pair back to 1.1450.

The option barriers may keep the EURUSD in check at least until the New York cut today at 1400 GMT, but the pair remains well supported both technically and fundamentally. Today news that Industrial Production rose 4.0% versus 3.0% continues to suggest that economic activity in the region continues to improve and it is only a matter of time before ECB joins the Fed in normalizing monetary policy.

Elsewhere in Europe, the UK labor numbers offered a small upside surprise with 3 month employment rising to 175K from 120K eyed. UK unemployment rate stands at 4.5% which is the lowest since 1975. On the other hand average wages came in well below the inflation rate at 1.8%. ONS noted that the timing effect of bonuses was partly to blame for lower earnings but it does not mitigate the fact that annual wage growth now stands -0.7% and will likely weigh on consumer spending going forward. Cable rebounded slightly to 1.2850 but remains a relative weakness trade as markets continue to worry about Brexit negotiations. One of the fresh concerns is that a failure to reach a workable compromise will necessitate a downgrade of UK sovereign debt which could have massive negative consequences for the currency going forward.

In North America today the focus will turn to Janet Yellen’s testimony and the BOC rate decision both due at 1400 GMT. With markets expecting a relatively hawkish tone from both events, the true surprise could be to the downside. Ms. Yellen is expected to maintain her tightening bias likely stating that the Fed will continue to normalize rates at a gradual pace. Friday’s NFP data offered little reason for Fed to reconsider its policy path, although both wage growth and inflation remain subpar.

Nevertheless, Ms. Yellen is expected to argue that inflationary pressures will return and that it is necessary for the Fed to remain ahead of the action rather than react impulsively. Of greater interest to the market will be Ms. Yellen’s comments regarding the Fed’s 4.5 Trillion dollar balance sheet. For now she is expected to demur on any commitment to trim the inventory and begin the unwind process anytime soon. If, however, she suggests that the Fed is seriously considering the start date of balance sheet reduction, the dollar will pop on the news as this act will no doubt push US rates higher. Still, with US economy still in a very low growth rate environment, it’s doubtful that Ms. Yellen would press for double tightening of credit conditions via both rate hikes and inventory reductions at the same time.

Finally in Canada the market anticipates a rate hike from the BOC today with expectations now priced in at 93%. Therefore, if the BOC balks USDCAD is likely to verticalize well above the 1.3000 level on any negative surprise. However, even if the BOC hikes rates, traders will be focused on BOC’s plans going forward. If Governor Poloz suggests that another rate hike is likely before the end of the year USDCAD could quickly sell off towards 1.2700. If on the other hand this rate hike is seen as one and done, the loonie will weaken as most of the positive news has been priced in over the past several weeks.

Boris Schlossberg
Managing Director

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