Dollar outlook: How will surging treasury yields affect Powell’s testimony

Fed Chair Powell Delivers Semi-Annual Testimony on Economy Tuesday

#EUR Rises on Stronger German Business Confidence

#GBP Hits Fresh Highs but UK Labor Data a Risk

#NZD Soars after S&P Upgrades Sovereign Rating

#CAD Climbs to 3 Year High

Federal Reserve Chairman Jerome Powell’s semi-annual testimony on the economy and monetary policy is one of the most important events this week. The broad based decline in the U.S. dollar is a sign that investors expect cautious comments. Approximately 1.7 million coronavirus shots are being administered every day and with 13% of the population receiving a first dose, the U.S. is charging ahead with vaccine rollout. There have been setbacks with many states including ours (New York) struggling with supply issues but a lot of that had to do with poor weather that delayed the delivery of about 6 million doses this past week. Supply will be less concerning in the coming weeks as manufacturing ramps up and the Food and Drug Administration approves Johnson and Johnson’s single dose vaccine. 

All of this is important because it reinforces the possibility of a strong U.S. economic recovery. However even if the outlook is bright, there’s very little reason for the central bank to shift course especially with the recent surge in Treasury yields. Rising rates and the steepening yield curve are two of the biggest stories that emerged in the financial markets this year. Since January 1st, ten year rates rose from 0.91% to 1.39%. This double digit increase is fueled by a ramp up in inflation expectations and concerns about central bank action. 

So the question now is how does this impact Powell’s testimony. It gives the central bank head more flexibility to keep monetary policy accommodative because the rise in Treasury yields tightens financial conditions by driving up mortgage and credit card rates. Powell has made it very clear during his speech to the Economic Club of New York two weeks ago that he thinks the increase in inflation is temporary and even if prices rise in the coming months, “it isn’t going to mean much.”  He also advocated keeping interest rates at the current near zero level until the economy reaches maximum employment and inflation hits 2 percent to ensure a durable recovery. Since then, data has been mixed with retail sales recovering but job growth falling short of expectations and jobless claims back at their highest level in a month. 

With all of this in mind, we expect Powell to downplay the increase in prices and reiterate that accommodative monetary policy is needed for the foreseeable future. Any talk of taper is premature.  Dovish comments like this should extend the slide in the dollar, taking USD/JPY towards 104.50 and AUD/USD to 80 cents.

Stronger than expected German business confidence drove euro higher against the U.S. dollar for third day in a row. However compared to other currencies, euro’s gains were more modest because investors are worried about the central bank’s sensitivity to the strong currency. The ECB didn’t mention exchange rates today but they said they are watching the rise in yields closely. Compared to U.S. and U.K., vaccine rollout in the Eurozone has been painstakingly slow. Germany, the largest economy in the EZ has vaccinated only 4% of their population. The vaccination rate in France, Spain and Italy are slightly lower. We have argued that this lag will lead to the euro underperforming other major currencies, which is exactly what we’ve seen today.

Sterling climbed to fresh multi-year highs against the U.S. dollar and closed in on fresh 1 year highs versus euro. Investors cheered Prime Minister Boris Johnson’s plan to ease restrictions across England. With more than a quarter of its population receiving at least one coronavirus vaccine dose, new cases in the U.K. have fallen from a high of 68K in January to 9.8K on Sunday. Schools will reopen on March 8th followed by outdoor gatherings March 29th. There will be a five week gap between each stage which means restaurants, retail shops and pubs may not open until Spring. U.K. labor market numbers are scheduled for release tomorrow and if claimant count increases like the PMIs suggest, we could finally see a pullback in sterling.

The Australian and New Zealand dollars continue to be the best performing currencies. S&P upgraded New Zealand’s credit rating to AA+ from AA, sending the currency to 34 month highs vs. U.S. dollar. They said “New Zealand is recovering quicker than most advanced economies because the country has been able to contain the spread of Covid-19 better than most others.” This strength extended to the Australian dollar as the country shares the same promising outlook as NZD. The Reserve Bank of New Zealand meets this week and less dovishness is expected from the central bank. USD/CAD fell to fresh 3 year lows but on a percentage basis, its gains were modest because weaker data is offset by stronger oil prices. Canada is also trailing the world in vaccination with only 3.8% of their population receiving their first dose. Supply is a big problem because they invested into European factories in fear of U.S. export bans. These factories are struggling to keep up with demand and recently the EU said they will be introducing export controls on vaccines made in the bloc which could delay vaccine delivery further.