Dollar Heavy, Bonds And Emerging Markets Rally

The dovish take to Fed Chair Yellen’s testimony yesterday has continued to weigh on the dollar and support global bond markets. Equities are mixed with the major markets lower while emerging markets have rallied. The MSCI Emerging Market equity index is up about 0.8% to reach its highest level since early last December.  

Emerging markets and the Antipodean currencies were also aided by the better than expected China flash manufacturing PMI from HSBC. It rose to a four-month high of 50.1 from 49.7 in January. The market had expected a slight decline.  

The Canadian dollar is participating fully in the move against the greenback.  It was not just Yellen, but the Bank of Canada Governor Poloz reiterated that the surprise January rate cut was an insurance policy. His suggestion that it bought time to see how the drop in oil prices were impacting the economy was seen as a signal that the may not be a rate cut next week as many had been expecting, given the soft data and recent dovish comments from BoC officials. 

The more we reviewed Yellen’s remarks, the more we are convinced that the Chair is preparing investors for a change in the forward guidance at the next meeting in the middle of March. She is facilitating a shift from date-specific to data-driven guidance. In particular, we are struck by her effort to push back against the doves arguments about inflation being too low and the global headwinds being too strong.  

She specifically argued that the decline in oil prices were not only depressing headline inflation, but also bleeding into the core rate. She reiterated that the inflation impact from falling energy prices was temporary. On the other score, Yellen did not argue that US was immune to global developments. Instead, she suggested that the forces were broadly neutral.  

The drop in oil prices and the downward pressure on interest rates was offset by the rise in the dollar. Yellen specifically said that domestic demand and spending were sufficiently strong to put the US economic recovery on firm footing.