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Summer lull hits markets, Yellen's testimony in focus
Will Yellen be tellin’?
Investors appear to expect a dovish statement today from US Federal Reserve Chairwoman Janet Yellen , i.e. a ‘Goldilocks’ not-too-fast, not-too-slow approach to monetary policy. So, we believe that the risk is mostly on the upside in USD: if Yellen surprises and comes out hawkish, investors will be scrambling to buy USD.
Yellen’s scheduled remarks, to the US House of Representatives at 10.00 Washington time, offer a big opportunity to explain the Fed’s plans on interest-rate hikes and on its upcoming balance sheet run-off. Details have so far been scarce. Many investors were disappointed by the limited information provided in the transcripts of June’s meeting of the Fed’s Open Market Committee.
Her remarks are also are the only significant event planned for today. Otherwise, the markets are in the doldrums of mid-summer. Volumes are low, equity indices and currencies are going nowhere. After edging slightly lower on Tuesday, European markets opened in positive in territory with the DAX and Footsie rising 0.39% and 0.67% respectively. The picture is not much brighter in the FX market with most currency pairs treading water for the past few days. The pound sterling rose 0.35% against the greenback yesterday before falling 0.85% to 1.2825 after a Band of England report showed Deputy Governor Broadbent is reluctant to support a rate hike for now.
Hardly a taper tantrum: bonds were overpriced, too
Last week’s rally in bond yields was not just a reaction to central banks’ effort to return to ‘normal’ interest rates. It also was a reaction to expensive bond positions. Bonds have been overvalued for a significant period, with little duration-risk priced in. It seems that the shift in monetary policy woke up the market to this overvaluation.
Central banks are clearly bent on ‘normalization’, and the US Federal Reserve is leading the way forward. We expect to see a gradual tightening of money by the Fed, led by balance sheet reductions and modest interest-rate hikes. Still, the Fed is not yet taking the aggressive stance it took in 2013, which pushed rates up 25 basis points across the curve. Indeed, we see the Fed taking no more than a 25 bp increase for the balance of 2017.
Although inflation still has not caught fire, Fed Chairwoman Janet Yellen says this is transitory, and she continues to push firmly for further rate hikes. We think she will ultimately have her way, and when her rate increases are followed by those of the European Central Bank – which in due course will surely happen – then we expect a significant market reaction.
Will Canada raise interest rates tomorrow?
On Thursday, the Bank of Canada will decide whether to raise rates. Will interest go up again, as it has over the past month?
On the one hand, the BoC has a decidedly hawkish view. Currency traders have been convinced enough to price in 67 basis points worth of rate hikes for the coming 12 months. On the other hand, the Canadian economy suffers from weak inflation (led by soft wage growth) and significant exposure to external risk – think oil, gas and mineral prices.
In our view, the BoC’s Thursday choice will depend on its reading of the deep data. If they can, they will tighten money, but not automatically. We suspect the markets have overanticipated rate hikes, and that weak oil prices and current account deficit will take 25bp off of the table. In a nutshell: stay long USD/CAD.