FX: 3 Key Takeaways from Yellen's Testimony

No decisions have been made about raising interest rates in March according to Janet Yellen but don't be mistaken - the odds of tightening next month is declining rapidly. Given the sharp sell-off in global equities, the strong dollar and a continued drop in oil prices, the Fed Chair's back was against the wall and she had no choice but to acknowledge the new pressures on the U.S. economy. According to her testimony, the central bank is no longer looking to raise rates 3 to 4 more times this year like the December dot plot suggests because we're now looking at only 1 and at best 2 rate hikes in 2016. With that in mind, Yellen hasn't completely given up on the idea of raising rates in March. She stuck to her guns and reminded everyone about the strength in the labor market and the benefit that higher wage gains should have on incomes and spending.

Investors initially bought dollars after Yellen's testimony because she hadn't cooed loud enough but by the end of the NY session they realized that chances are the Fed won't be pulling the trigger next month. They wanted the Fed Chair to confirm that rates won't be rising in March and while she implied that, she stopped short of being specific because there's no sense pre-committing to a decision before the next NFP report. We are not looking for an interest rate hike next month but with 5 more weeks to go before the Fed meeting we cannot rule out dollar short covering in the weeks ahead especially after such a strong move. Keep an eye on the markets because in her testimony before the House Financial Services Committee Yellen said "U.S. financial conditions have become less supportive" and these strains if persistent, it "could weigh on the outlook." She also noted that economic developments abroad pose risk to U.S. growth and that inflation expectations are at the low end of the spectrum. However the improvements in the labor market can go a long way in supporting the economy and according to Yellen, the "economy is in many ways close to normal" and there's "good reason to think inflation will rise over time."

In a nutshell, the 3 main takeaways from Yellen's testimony today are the following:

1. Fed hasn't made up its mind about March but chances are they won't
2. They are very worried about financial market volatility, strong dollar, wider credit spreads and low oil prices
3. But they are optimistic about the labor market and the impact that wage gains will have on spending

The euro took a beating today because the same concerns that trouble the Fed have been haunting the ECB for weeks. Year to date, European stocks are down anywhere between 8 to 20% compared to 7 to 14% in U.S. indices. Spanish, Italian, Portuguese and Greek bond yields spiked, leading to higher borrowing costs for nations that can barely afford to service current debt. Add to that global market volatility or low oil prices and we can understand why there are rumors floating around that the ECB could buy bank stocks as part of an expanded QE program. The ECB was serious about the possibility of increasing stimulus in January and with conditions worsening since then, their resolve will have increased over the past few weeks. EUR/USD should be trading much lower but the attack on U.S. dollars needs to ease first.

Big intraday swings in oil prices continue to drive big moves in USD/CAD. At the start the NY session oil was lower, then it jumped after inventory data but before long it was down once again. The persistent decline in oil prices is bad news for Canada's economy and when combined with the weakness in the labor market, we should be looking at USD/CAD well above 1.40. In contrast, the Australian and New Zealand dollars traded slightly higher versus the greenback following stronger data. Australian consumer confidence rebounded in February while New Zealand credit card spending ticked higher.

The British pound ended the day unchanged against the greenback after trading sharply higher. U.K. industrial production dropped -1.1% in the month of December and turning negative year over year. The data had a limited short-lived impact on the currency, which recovered quickly on the back of EUR/GBP selling. However by the end of the NY session, risk aversion erased the gains in sterling. Ultimately the recent turn in data and risk of Brexit makes GBP a less attractive currency.