Yellen Fails to Deliver but Is the Dollar Dead?

Investors have been skeptical of the Fed's hawkishness in the days leading up to Janet Yellen's testimony and when she failed to sufficiently emphasize the improvements in the economy, the dollar U-turned as the bulls abandoned their trades quickly. USD/JPY dropped below 113 and EUR/USD rose to 1.1480.  However by the end of the North American trading session, USD/JPY moved back above 113 to settle above this key level and EUR/USD came off its highs after having dipped briefly below 1.14.  This leads investors to wonder if we've seen the end to the dollar's rally, at least for the time being.  To answer that question, we need to look at what Yellen said. In her prepared comments, she said additional gradual rate hikes will be needed over the next few years but rates won't have to rise much further to get to neutral. More importantly she said everything hinges on inflation, which is the key uncertainty and right now it is running below their goal, having declined recently. These are not the words of a hawkish central banker who wants to pound the table for additional tightening this year and with another move not expected to happen until December, time is on their side.  So while we don't think the dollar is dead, we could certainly see USD/JPY drop to 112.50 possibly even 111.80 before buyers dip back in.  At the end of the day, the Fed is still telling us rates will rise again but September is off the table.  

The Canadian dollar on the other hand took out 3 big figures to rise to its strongest in nearly a year versus the U.S. dollar.  As expected the Bank of Canada raised interest rates by 25bp and upgraded their 2017 and 2018 GDP forecasts. They attributed the slowdown In inflation to temporary factors and while Governor Poloz said they need to carefully gauge the impact of higher rates, he also there is "no doubt interest rates will be higher over time." With the recent improvements in data, the "economy no longer needs as much stimulus" and the upward revisions in GDP showed the output gap closing sooner than they previously anticipated according to Deputy Governor Wilkins. Poloz now sees inflation returning to their target level within a year.  These unambiguously positive comments created a second wave of CAD buying that should take USD/CAD down to 1.25. The Australian and New Zealand dollars also benefitted from the slide in the U.S. dollar and higher commodity prices.  AUD/USD rose for the fourth day in a row as consumer confidence rebounded in the month of July.  China's trade balance is scheduled for release this evening and the level of imports / exports should have a significant impact on AUD and NZD.  While AUD/USD looks like it could hit 77 cents, NZD/USD has significant resistance near 0.7285. 

The most unusual performance today was in the euro, the only currency that did not benefit from the anti-dollar rally. Instead of rising like the JPY, GBP, AUD, CAD and NZD, the euro fell sharply after Janet Yellen's testimony.  Data was good with Eurozone industrial production rising more than expected.  In fact, the pace of growth in May was the strongest in 6 months. Wholesale sales in Germany also stabilized after falling the previous month.  The only thing holding EUR/USD back is the decline in European yields.  The European Central Bank meets next week and there's some worry that they may not be eager to talk taper. 

Sterling on the other hand held up well throughout the North American trading session thanks to stronger labor data. The 175K increase in 3 month employment was well above the market's 120K forecast. Jobless claims rose less than the previous month and while average weekly earnings growth slowed to 1.8% from 2.1%, earnings ex bonuses grew at a faster pace of 2%.  Although these numbers do not scream rate hike, between the sell-off in the U.S. dollar and technical support above 1.28, the labor market report was the perfect excuse for sterling bulls to bid up the currency but as long as GBP/USD holds below 1.2930, we are still bearish.  Bank of England member Broadbent did not talk monetary policy in his speech today but in a newspaper interview, he said point blank "he is not ready to support a rate hike" as he "sees lots of imponderables in economy."  So as long as GBP/USD holds below 1.2930, we still see a move down to 1.2720.