Yellen’s dovish comments boost investors’ spirits

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Equity markets closed out the first quarter of the year on a strong note, with the S&P rallying 0.79% after Janet Yellen spoke in Chicago and reiterated the FOMC’s commitment to offer extraordinary support for the US economy due to the fact that the job market is still not back to “normal” health.  Investors were joyous with Yellen’s dovish comments that the Fed takes their 2% inflation goal seriously, and that tapering is not a lessening of their promise remove some of the considerable slack in the economy.  As the new head of the FOMC dialed back expectations for a quickening of interest rate increases once QE has been wound down, Yellen also made mention that the depressed labour participation rate overstates the health of the labour market, signalling additional employment metrics such as hours worked and the percentage of the workforce underemployed will be eyed more closely by the Fed moving forward.  The VIX future curve slid across the board, however most of the damage was done on the front-end as the cash contract fell by 3.68% to finish under 14%.  Yields on the 10-year US treasury move higher throughout the North American session, but lost faith in the equity rally and sunk lower into the close to finish at 2.72%.

The overnight Asian session was a busy one, highlighted by the Reserve Bank of Australia’s monetary policy meeting and the decision of the central bank to hold interest rates unchanged at 2.5%.  The pronouncement to forego an altering of policy confirms the RBA’s preference to keep rates stable for the near future as the economy continues to rebalance, making it apparent Governor Stevens would rather use a depreciating domestic currency to provide additional support to the economy.  Stevens noted that while a weaker Aussie from the same time last year would help the economy achieve balanced growth, the rise over the last few months will temper some of that optimism.  While the decision to keep interest rates unchanged was widely expected, the Aussie weakened after the Governor’s comments surrounding the Antipodean currency, with AUDUSD edging into the low 0.92s during the overnight session.

On the economic data front, China continues to paint a mixed picture when measuring purchasing activity in its manufacturing sector, with the official government Manufacturing PMI print hitting expectations to print above the 50 level at 50.3, while the final HSBC Manufacturing PMI slipped to 48.0.  With the official reading showing modest improvement over the last three months, this has strengthened the stance we will not see large stimulus activity from the government, most likely choosing to proceed with a targeted fiscal stimulus in order to support some of the weaker areas of the economy.  That being said, the macro-economic picture for China is still bleak and a worry for those economies that rely on China to drive export demand, with restrained fiscal policy from the beginning of the year holding growth back.

Speaking of the potential for further stimulus measures, the Bank of Japan’s quarterly Tankan survey of large manufactures came in slightly worse than had been expected by analysts, with a sharp drop seen in the outlook portion of the survey as businesses worry about the knock-on effects of the new consumption tax effected today.  The business conditions forecast dropped to a one-year low, adding weight to the argument Governor Kuroda and the BoJ will most likely shore up their asset purchase program in the coming months to try and offset some of the potential weakness attributable to a decrease in consumption from the new tax hike.  The Yen garnered a steady offer tone throughout the overnight session, with USDJPY heading into the mid-103s ahead of the opening bell.

A quick check of European equities shows risk-appetite is well supported heading into the North American hand-off, with the major bourses firmly in the green after the unemployment rate in the Eurozone held firm at 11.9% in February, with January’s reading being revised lower from 12.0% to 11.9%. The better than expected employment statistics were somewhat mitigated by the fact that the unemployment rate in Italy diverged from the common-currency bloc, with the jobless rate increasing to 13% in February.  The increase in unemployment in Italy highlights the differences in conditions from the core to the periphery, with Germany continue to hold the zone above water as its export sector remains resilient; however, it begs the question as to how long Germany will continue to drag-along the overall zone.  The EUR has grinded upwards against the USD since the release of the stronger than forecast employment numbers, with EURUSD looking to try and regain the 1.3800 handle.

Turning our attention to North American markets, equity futures are looking to build on their gains from yesterday, and kick off the second quarter in positive territory.  The Loonie is slightly stronger against the big dollar to the south, with some slight buying interest on the back a warmer than expected reading on raw material prices for the month of February.  As a leading indicator of consumer inflation, the monthly increase of 5.7% bodes well for the Canadian economy that has struggled with increasing consumer price levels; however, we’re unlikely to see a substantial economic driver for the Loonie until Thursday brings trade balance figures for February.  USDCAD is pivoting in the mid-1.10s, likely to be range-bound today between 1.1000 and the 50-day moving average at 1.1085 unless there is a material deviation from what economists are expecting for the ISM Manufacturing PMI out of the US.

Looking ahead to the remainder of the session, the busy day in terms of economic data does not materially calm down.  The ISM PMI survey for the US Manufacturing industry is due out at 10:00EST, and forecast to come in at 54.0, a slight improvement from the 53.2 reading that was registered in February.  A print north of the all-important 50 level and a resumption of the upward trend since January’s large decline will bode well for future economic prospects, with strong focus honing in on how the employment sub-index performs, and how that could affect the outlook for the big Non-Farm Payroll report due to be released this Friday.  Should manufacturing activity in the US show employment and prices were sluggish over the month of March, currency markets will likely see the USD underperform, as it increases the chances the length of time after QE is wound down before rates start to increase is stretched past six-months.

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About Author

Scott Smith is a Senior Corporate Foreign Exchange Trader with Cambridge Mercantile Group and has a diverse background in the foreign exchange industry, with previous experience in both credit and trading related functions. Scott holds a Bachelor of Commerce degree from the University of Victoria, has completed all three levels of the Chartered Financial Analyst designation, and is currently working towards the Derivative Market Specialist certification offered through the Canadian Securities Institute. Cambridge Mercantile Group.

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