Dollar rally takes a breather during uneventful week
18/Nov/2013 • Currency Updates•
The main focus of FX markets for the week was Yellen’s confirmation hearing at the US Senate in her bid to succeed Ben Bernake at the helm of the Federal Reserve. She steadfastly refused to offer any hints to investors as to the exact timing of the “tapering” of monetary stimulus in the US. As a result currency markets drifted without a clear direction during the week, as did Emerging Markets and credit. Not so US equity markets, which continue to post record highs almost daily. We maintain our expectation of a sooner than consensus January taper and therefore expect the dollar rally to continue over the medium term.
The Bank of England Inflation Report suggested that the MPC has acknowledged the stronger-than-expected recovery of the economy, driven by internal demand and the labor market. The BOE now expects that there is a 50% probability of the unemployment rate falling below the 7% threshold in mid-2015 or earlier, up from 2016 in the August report. The October employment data provided strong support for this shift.The claimant count fell by a whopping 42,000. We don’t pay a lot of attention to the unemployment rate from the report, which is extremely volatile and less reliable than the ILO measure, but the sharp drop we saw in the former bodes well for the latter. Sterling reacted well to the news and outperformed both the euro and the dollar.
Our view of a European “permacession” received further support from last week’s depressing GDP growth report. The eurozone as a whole eked out a barely noticeable 0.4% SAAR (Seasonally Adjusted Annual Rate) of growth. Average growth for the past two quarters stands at 0.7%; not the number you want or expect to see after the longest contraction in European history, and nowhere near enough to turn around either the labor market or the sovereign finances of the periphery. At this point, the only stimulus we see to the European economy will come from a sharp devaluation of the currency, and therefore maintain our bearish stance on the euro.
As we remarked above, Yellen’s testimony at her confirmation hearing left markets no wiser as to the question in everyone’s mind: the exact timing of the taper. Absent any Delphic pronouncements from the Fed, traders were left to pick through the week’s economic dataflow. The string of second-tier reports on trade, manufacturing and inventories leaves our 2-2.5% estimate for real final domestic sales (i.e. excluding inventory accumulation and trade) intact. This figure is consistent with monthly net job creation in the 150-200,000 range and a January taper, and therefore we expect the dollar rally to continue over the next few months.