There’s been a whole heap of economic data released in the past 24 hours along with Fed Chair Yellen’s important semi-annual testimony to lawmakers. The net result of all this is fairly flat equity markets, a slightly stronger USD and higher US Treasury rates.
Yellen played a straight bat and broadly reiterated her previous messaging, forecasting ongoing progress toward the Fed's goals and gradual policy tightening. She kept the door open for a possible March rate hike by repeating her line that “…waiting too long to remove accommodation would be unwise, potentially requiring the FOMC to eventually raise rates rapidly, which could risk disrupting financial markets and pushing the economy into recession”.
The USD major currency TWI is up 0.3%, with all the gain coming after Yellen’s testimony was published. OIS pricing for a March hike nudged up slightly from 9bps to 10bps, while more than two full hikes are now priced for this year, some 57bps (previous close was 54bps). US Treasury rates are up across the curve, with the 2-year rate up 3bps to 1.23% and the 10-year rate up 5bps to 2.49%. The market was tightly range-bound ahead of the testimony with the jump in yields following that.
There was some interest in Yellen’s comments on the Fed’s balance sheet as that could have a significant impact on US Treasuries in the years ahead.
She didn’t give much away, commenting that “…she expects the central bank’s balance sheet to wind up being “substantially smaller” than it is now, and policy makers want it to shrink in an “orderly and predictable way.”
Ahead of Yellen’s testimony there were a number of key data releases. These showed stronger inflationary pressure in China and aggregate financing, slightly softer than expected Germany and euro-area activity indicators, slightly weaker than expected UK CPI inflation, stronger US PPI inflation and US small business optimism rising to a fresh 12-year high.
JPY has been the weakest performer, maintaining its close correlation to US Treasury rates, with USD/JPY up 0.6% to 114.40. Much of the fall in GBP occurred after the softer CPI data. GBP/USD is down 0.5% to 1.2465. EUR/USD is down 0.3% to 1.0570.
The NZD maintained a tight range yesterday and has fallen from around the 0.7180-0.7190 mark to be currently 0.7150 in the aftermath of Yellen’s testimony. With risk appetite remaining high, with the VIX index hovering down around 11, that takes the NZD further away from our fair value estimate around the 0.74 mark.
There was little market reaction to the surge in January food prices, which cements in our Q1 CPI estimate of 2.0% y/y, well ahead of the RBNZ’s 1.5% y/y. To be sure, some of the increase in food prices will be unwound in the next month or two, but it adds supports to our view that CPI inflation will be running well ahead of RBNZ estimates this year and that will test its resolve to keep policy unchanged for almost three years.
After the RBNZ’s clear message last week, the local rates market wasn’t in a mood to price in tighter policy. Bill futures moved 0-1bps, while the 2-year swap rate was steady at 2.35%. The 10-year rate swap rose by 2bps to 3.49%. Under the circumstances, NZ yields were resilient in the face of higher Australian rates, triggered by the NAB monthly business survey. This survey showed business conditions jumping to a level last seen during the boom before the Global Financial Crisis. It was another nail in the coffin for those Australian economists thinking that the RBA is likely to ease policy again this year.
The NAB survey pushed the AUD higher, a steady increase from 0.7650 to just under the 0.77 mark before meeting resistance. Yellen’s testimony then drove the currency all the way back down and is currently 0.7640. NZD/AUD was tracking higher ahead of the NAB survey and reached 0.94, but fell after that release and this morning the cross trades around 0.9360.
The local rates market will see upward pressure on the open, reflecting the push higher in US rates. There are few data releases in the local session so attention turns to US CPI and retail sales data tonight. Stronger than expected readings would add to the chance of a March Fed hike and push the USD higher. Weaker data could see a reversal of the USD and rates moves this morning.
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