10Y dollar fed fomc yellen

Did The Market Misread The Most Important Event Of The Week?

So we got a hawkish Yellen on Capitol Hill. Or did we?

So we got a hawkish Yellen on Capitol Hill.

Or did we?

The market certainly seemed to think so. Rates and the dollar spiked hard when the Fed Chair’s prepared comments hit the wires on Tuesday morning.


Note the subsequent dollar dip into week end.

Many market participants were confused. “A good meeting between Presidents Trump and Abe, strong US data, including higher than expected inflation, and a somewhat hawkish tone by Yellen in her Congress testimony supported the DXY early in the week,” BofAML wrote, adding that “then, the index went back where it started, for no clear reason.”

Bloomberg’s Richard Breslow noted this as well, writing the following on Friday:

Chair Janet Yellen was taken as hawkish. CPI was a clear beat. If you bought dollars on that you’re down money. If you hit the bid on some 2-year Treasuries as the headlines flashed, ditto. The 10-year U.S. Treasury yield printed the week’s low yield Friday, having approached year-highs earlier. Not what you would have been positioned for if you’d received the week’s news in advance.

Maybe the answer lies in jitters over Trump’s ability to deliver on his promised “phenomenal” tax plan. Or perhaps there’s speculation that the President and/or his economic spirit animal Peter Navarro will get back to jawboning the dollar lower.

Or maybe everyone simply misinterpreted Yellen. That’s Morgan Stanley’s contention. Consider the following from a note entitled “Selective Hearing.”

Via Morgan Stanley

Perception is everything. Bond market investors were hoping for a hawkish outcome, and the headlines did not disappoint. Our take is more benign. Chair Yellen stuck close to the spirit of the January FOMC statement and steered clear of numerical assignment or time stamp in terms of further hikes.

Chair Yellen laid forth a tall order around the dual mandate that both employment and inflation need to evolve in line with the Fed’s expectations. In particular, we think the spring data on core inflation will disappoint, making a near-term rate hike difficult.

We did not expect Yellen to repeat her “a few times a year” remark from her January 18 speech, and she didn’t. Instead Yellen cited that factors warrant “further gradual increases” in the fed funds rate, but avoided assigning it a number, or time stamp.

Changes in US fiscal policy were cited as one of the sources of “considerable uncertainty” around the economic outlook. Yellen and the Board need a clearer lens into the machinations of Congress to incorporate fiscal policy into the outlook.

We are in line with the consensus of economists and market-implied expectations for two hikes this year, but we differ on placement. We expect the next rate hike to come in September, while consensus places the greatest probability on the June meeting.

On the balance sheet, the Committee has no intention of using it as an “active policy tool”. In other words, don’t expect the Fed to substitute a reduction in the balance sheet for rate hikes.


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