Fears about the outlook of the Chinese and global economy as well as the impact from further Fed tightening triggered a violent reaction in the FX markets at the start of the year. Since then, however, the Fed has turned more dovish and that has helped prop up market risk sentiment while sending USD tumbling.
Going into the semi-annual testimony of Fed Chair Yellen next week investors seem to expect an extension of the cautious rhetoric. In addition, the Lunar New Year festivities should keep Chinese markets quiet and the country’s data calendar fairly light. All that should, in theory, create a favourable backdrop for the risk-correlated G10 currencies while the USD should suffer more.
That said, we think that those betting on Yellen hinting at emerging downside risks to the economic outlook in light of the latest tightening of global financial conditions could be disappointed. In our view, the Fed Chair should highlight that past bouts of financial market volatility have only had a temporary impact on the real economy and reiterate that the FOMC remains data dependent and, at present, is in wait and see mode. With markets not expecting any Fed rate hikes this year, a less dovish than expected testimony could help USD.
Elsewhere, the Riksbank should keep its rates stable but may revise down its conditional rate path to strengthen the monetary policy headwinds in place for SEK. While the risk-correlated and commodity currencies may benefit from some further USD-underperformance preYellen, they could struggle in the wake of the testimony.
EUR and JPY could remain supported against USD for now but the prospect for further ECB and BoJ easing should mean that the longer-term risks should remain on the downside.
What we’re watching
USD – Next week’s Congressional testimony by Fed Chair Yellen will be key in driving the USD and risk sentiment further. We do not expect a case of further falling rate expectations to be made here.
SEK – Although the Riksbank is likely to hold off from further easing next week, a dovish rhetoric should keep easing expectations to the detriment of the SEK intact.
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