Dollar Weakens Ahead of Yellen Testimony

Traders price in an 81% chance that the Fed will raise rates in December 2016

The U.S. dollar weakened against a basket of major currencies ahead of the release of vital inflation data and testimony from Federal Reserve Chairperson Janet Yellen on the economic outlook before the Joint Economic Committee of Congress in Washington D.C. on November 17th, 2016. Yellen’s testimony will help shape U.S. interest rate expectations and traders are pricing in an 81% chance that the Federal Reserve will raise U.S. rates in December 2016. The dollar also fell on bets that the Trump administration will adopt inflationary policies, while the yen sagged after a Bank of Japan (BoJ) bond-buying operation. Earlier during the week, the dollar gained on expectations that the Fed is on track to hike interest rates in 2016, and might have to take further action next year as well.

Source: Bloomberg
Source: Bloomberg

The U.S. dollar has witnessed volatility ever since Donald Trump was elected president on November 8th, 2016, fuelling expectations of major fiscal spending and sending U.S. Treasury debt yields soaring on the prospect of higher interest rates. The dollar dipped to 109.02 against the yen on November 17th, 2016, before recovering to close at 110.48.

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The dollar index, which tracks the greenback against six major rival currencies, eased 0.1% to 100.32 on November 17th, 2016, after climbing as high as 100.57 on Wednesday, its highest since April 2003.

With the weakening of the dollar, gold nudged up slightly, with spot gold inching up to $1,226.31 an ounce. Gold had still lost roughly $100 an ounce from the high reached on November 8th, 2016, on the back of a rise in bond yields and burgeoning appetite for risk.

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BoJ’s bond-buying operation

Meanwhile, the yen rose to 108.89 per dollar, though is still down more than 3% since Trump’s victory. The yen retreated from its intraday highs after the BoJ conducted its first special operation to curb rising yields on Japanese government bonds (JGBs). The BOJ’s JGB operation came at a time when moves in U.S. bond yields and U.S.-Japan yield differentials have been a focal point for the dollar’s moves versus the yen. The U.S. benchmark 10-year Treasury yield is now at 2.199%, after reaching a 10-month high of 2.302% earlier in the week.

The euro gained 0.2% to $1.0697, snapping an eight-day losing streak after slipping to as low as $1.06665 on Wednesday, its lowest level since December 2015. The euro could hit parity against the dollar in 2017, as Europe contends with political uncertainty and a weak economic recovery.

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Yellen testimony to focus on future monetary policies

At the upcoming testimony by Yellen, investors are bracing themselves for higher interest rates and inflation, and anything she might say about the recent rise in the dollar and U.S. bond yields. Yellen will be addressing Congress for the first time since Donald Trump’s victory in the presidential election. While a December rate hike is highly expected, prospects for further tightening triggered a global bonds rout and boosted the dollar since the start of last week.

Investors will also look for clarity on how much of Trump’s campaign promises will become a reality. Trump’s proposals to cut taxes and boost infrastructure spending are seen to spur economic activity and inflation, while any dismantling of foreign trade agreements or imposition of import tariffs would be expected to hurt the U.S. economy. U.S. tech firms, most of which make their products overseas, could bear some of the brunt of any new trade restrictions.

Yellen will also likely focus on the current positive economic updates: unemployment rates has been steady at near 5% so far in 2016, increasing wages, inflation is moving toward the Fed’s goal of 2%, and rebounding growth in Q3 FY16 after a slump in H1 FY16.

Fed President Harker favors rate hike

Philadelphia Federal Reserve President Patrick Harker stated on November 16th, 2016, that he favored raising interest rates and that the U.S. central bank might have to hike rates more aggressively if the incoming Trump administration enacts a fiscal stimulus. However, the Fed has stuck to its stance to raise rates gradually. However, investors feel that inflation could rise if Trump follows through on his campaign promises to slash taxes and boost spending on defense and infrastructure.

More importantly, Harker said the Fed must distance itself from politics and policymakers will not change course due to shifts in public opinion. Harker’s comments came in response to questions over whether the new administration and Congress could enact laws that would crimp the U.S. central bank’s autonomy. Republican lawmakers have proposed that the Fed be subjected to regular audits to disclose more information about its decision-making process for interest rate policy. However, Fed officials say that they need to maintain some secrecy over monetary policy decisions in order to avoid buckling to political pressure.

Yellen is expected to walk a fine line to avoid making drastic monetary changes to keep pace with policies of Trump’s incoming administration. The focus now shifts to the Fed’s meeting on December 13th-14th, 2016, with economists predicting a 54% probability that the Fed will raise interest rates.

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