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Yellen and weak data push back taper expectations

Federal Reserve Janet Yellen’s testimony before the Senate banking committee spurred a rally in equity markets as the Dow and S&P 500 registered record highs. Yellen, a known dove, argued that the Fed’s bold steps to stimulate economic growth have been successful amid elevated unemployment levels of 7.3% and inflation that continues to run below the Fed’s 2% target.

Her remarks suggest that she will follow in the footsteps of the incumbent Chairman Bernanke in standing by the Fed’s ultra loose monetary policy until such point that the US economy demonstrates further improvement.

Yellen reiterated that “there is no set time that we will decide to reduce the pace of our purchases” which affirms the believe of many economists that the Fed will maintain its asset purchases in its upcoming meeting in December and may only begin to scale back in March. This would provide the central bank more time to evaluate if the strong job gains reported in October can be sustained in the subsequent months.

Asian stock markets traded higher with the Nikkei up more than 7% since last Friday on the back of Yellen’s testimony. The pair of USD/JPY rallied overnight to a two month high of 100.15 as risk appetite improved and comments from Japan’s Finance Minister, Taro Aso, to the parliamentary committee affirmed that currency intervention remains a necessary tool to stabilize markets for the government. A sustained daily close above 100 would set up a near term test of 100.61 for USD/JPY followed by the July high of 101.53.

Moving to Europe, the euro printed fresh daily lows with the release of inflation data which saw Eurozone annual CPI fall to 0.7% in October, it’s lowest since November 2009. The euro upon release slid to a low of 1.3430, and has since retraced its losses due to softer US fundamental data. The road for the euro-zone will be a challenging one as it faces the asset quality review and bank stress tests that can further undermine European banks in 2014. Many fear that the exercise will expose a ballooning capital hole that will require immediate attention. Further banking union discussions and ECB policy are other factors that will test the euro zone politically.

A report released earlier today from the European Commission on euro zone government budgets included warnings to Spain, Italy and France. It is clear that the southern peripheral nations of Italy and Spain are not making sufficient progress with Spain guaranteed to miss the EU mandated target of 3% of economic output by 2015. Spain’s deficit is expected to fall to 5.95% in 2014, and rising to 6.6% in 2015. The issue with Italy is that it continues to be one of the most indebted sovereigns in the euro bloc. Its debt is forecasted to reach 133% of GDP by year end, running behind Greece in first place. For France, the European Commission forewarns that the government will have to embark on more substantial reforms to spur growth.

Across the continent, North American indices are expected to open on a positive note despite disappointing US import, export prices and Empire State index. In October, US import prices contracted 0.7%, more than the estimated -0.4% while export prices declined 0.5% against consensus of 0.1%. NY Empire State Manufacturing index for November fell to -2.21 from October’s reading of 1.52. Other data on the docket include Industrial Production and Wholesale Inventories.

The Canadian dollar continues to trade in its recent range, unable to set a clear direction, not helped by mixed bag of data. On one hand, there was an improvement in manufacturing shipments in September which saw a gain of 0.6%, while on the other, existing home sales fell 3.2% in October from September. USD/CAD is likely to trade sideways as we round up the week, as traders look ahead to next week’s inflation print. A further decline in headline inflation, below 1% will place pressure on the Bank of Canada’s inflation target between 1 and 3%, translating to a more dovish central bank and potential CAD weakness. Technically, a break below 1.0460 will allow USD/CAD to test support at 1.0440 and then 1.0400. On the upside, resistance is located at 1.0542, 1.0568 and 1.0594.

By  Cheryl Girling of Cambridge Mercantile Group