Yellen’s dovish rhetoric knocks USD to fresh lows

Fed Chair Janet Yellen’s speech at the Economic Club in New York yesterday was one of the more informative Fed speeches of recent memory as she calmly and clearly laid out the conditions required for further policy tightening; financial stability overseas, a cap on near-term Dollar strength and less volatile commodity and housing markets in the US. At present, the market has only fulfilled one of those conditions as the Dollar fell to weekly lows against both the euro and Sterling.

As mentioned in yesterday’s morning update, the core Fed members have their eyes on overseas markets, not on domestic developments when it comes to assessing policy risk – and the concerns over a stronger Dollar clipping inflation in a tightening cycle trumps the fear of keeping rates too low for too long.

Fed acting in April no longer on the cards

Market pricing of rate expectations shifted after Yellen’s commentary – knocking odds of monetary tightening to 0% at the April meeting (from 10% last week) and June’s odds fell to 28% from 46%.

As a result, the Dollar softened, benefitting equity, bond and commodity markets worldwide and sending GBP/USD towards 1.44. Yesterday’s rally brings monthly highs printed two weeks ago at 1.45 into contention, but there’s still a long way to go before 2016’s 2.6% losses are erased.

Bank of England warns of threats to financial stability

Yesterday, the Bank of England’s Financial Policy Committee issued a thinly veiled warning on the dangers of Britain voting to leave the EU, stating that the outlook for financial stability has deteriorated since November’s report. The Bank cited the UK’s significant current account deficit (heightening our sensitivity to foreign investment flows) and availability of financing for both individuals and corporations as sources of instability.

Although the report itself offered little that the market hadn’t already grasped, Sterling’s behaviour over the past few months backs the FPC’s assessment. 3-month volatility remains elevated, with activity in options markets pricing in a move of as much as 4.6% in the wake of the June 23rd vote. Such options pricing is relatively rare, and is the result of the neck-and-neck nature of the polls we’ve seen over the past few weeks, which seem only to conclude that the race is too close to call.

Today’s calendar quiet, but risk-heavy toward the end of the week

Calendar events are relatively thin on the ground today, with US ADP Employment Change (often seen as a somewhat inaccurate bellwether for Friday’s Nonfarm Payrolls) the only tier 1 release – but this will likely play second fiddle to Eurozone CPI due tomorrow and the US jobs report on Friday.

Have a great day.