U.S. Dollar Heavy, Bonds And Emerging Markets Rally

The dovish take to Fed Chair Yellen's testimony yesterday has continued to weigh on the dollar and support global bond markets. Equities are mixed with the major markets lower while emerging markets have rallied. The MSCI Emerging Markets equity index is up about 0.8% to reach its highest level since early last December.

Emerging markets and the Antipodean currencies were also aided by the better than expected China flash manufacturing PMI from HSBC. It rose to a four-month high of 50.1 from 49.7 in January. The market had expected a slight decline.

The Canadian dollar is participating fully in the move against the greenback. It was not just Yellen, but the Bank of Canada Governor Poloz reiterated that the surprise January rate cut was an insurance policy. His suggestion that it bought time to see how the drop in oil prices were impacting the economy. This was seen as a signal that there may not be a rate cut next week as many had been expecting, given the soft data and recent dovish comments from BoC officials.

The more we reviewed Yellen's remarks, the more we are convinced that the Chair is preparing investors for a change in the forward guidance at the next meeting in the middle of March. She is facilitating a shift from date-specific to data-driven guidance. In particular, we are struck by her effort to push back against the doves arguments about inflation being too low and the global headwinds being too strong.

She specifically argued that the decline in oil prices were not only depressing headline inflation, but also bleeding into the core rate. She reiterated that the inflation impact from falling energy prices was temporary. On the other score, Yellen did not argue that the US was immune to global developments. Instead, she suggested that the forces were broadly neutral.

The drop in oil prices and the downward pressure on interest rates was offset by the rise in the dollar. Yellen specifically said that domestic demand and spending were sufficiently strong enough to put the US economic recovery on firm footing.

Yellen delivers the same prepared remarks to the House of Financial Services Committee. The questions from the Representatives will be different, but her answers will be the same. Past Chairs often appeared to use the second day of testimony to try to help clarify the delivered remarks if they thought the market's reaction was not in the direction that it wanted it to be. We suspect that Fed officials were just as surprised as us with the dovish market reaction.

Minutes from this month's Riksbank meeting were published. Rather than emphasize the clear indication that the Riksbank could quickly move to expand its monetary stimulus, with its first bond purchases under QE to be launched tomorrow, the market focused what appears to be a high bar for additional action. Ingves even suggested underlying inflation may be bottoming out. Another board member expressed skepticism of the impact of QE in Sweden. The market took the euro down to SEK 9.4625, a two-week low. The next immediate target is SEK 9.43 and then SEK 9.37.

The Riksbank meets again on April 29th. By then, the impact of the ECB's bond buying program can be assessed. The SEK 10 bln bond buying program and the -10 bp repo rate is relatively modest compared to others in Europe. Hence the ability to scale up the efforts, if needed. The key is not so much the real sector. At the end of the week, Sweden will report Q4 GDP and January retail sales. The economy is expected to have expanded by 0.5% in Q4 after 0.3% in the previous quarter. Despite the deflation headwinds, retail sales are expected to have risen 0.5% as well, offsetting the 0.6% decline in December, and lifting the year-over-year rate to 3.8%, which is the average in 2014.

The heavier US dollar tone has helped lift sterling through the $1.55 level for the first time since early January, setting off some buy stops. Resistance is seen in the $1.5550-70 area ahead of the year's high set on January 1st, just below $1.56.

In addition to Yellen’s testimony, there are two other highlights for the remainder of the session. First, ECB’s Draghi testifies before the European Parliament. Investors are keen to hear what Draghi says about the recent developments in Greece; where the ECB President did not seem as favorable as the EC, and more details about the asset purchase plan, which will be launched next month. Second, are the US oil inventories. Yesterday, API said that crude stocks rose 8.9 mln barrels last week. API figures are based on voluntary reports by refineries, bulk terminals, and pipelines. The Department of Energy’s EIA provides the official estimate today. It is expected to show a 4 mln barrel build. It is based on government-required reports.