The US dollar seems to be caught between a dovish President Trump and the hawkish central bank. After trading weaker for the most part of January, the US dollar was seen rising steadily since early February despite some setbacks on allegations of currency manipulation by the US administration on some of its key trading partners.
This week, it was the turn of hawkish Fed. Much to the market surprise, Ms. Yellen’s remarks were more hawkish than expected, especially after considering that the Federal Reserve’s last meeting in early February did not carry much detail on the timing of the next rate hike.
5-yr break even inflation rate (as of week ending Feb 10, 2017)
The rather uneventful Fed meeting alongside weaker pace of wage growth saw the markets settle into a sense of complacency with the expectations for a rate hike at the March meeting falling. Investors were woken up this week as the Fed Chair told lawmakers during her two-day annual testimony to Congress that the Fed cannot afford to delay rate hikes any longer for fear of falling behind the curve and ending up having to hike rates at a faster pace than it expected, even risking recession.
Ms. Yellen gave a broadly positive report on the U.S. economic outlook noting that the job market was strengthening albeit some slack still remaining. She was also positive on inflation that it would rise to the Fed’s 2% rate. This view was later confirmed by market reports on Wednesday as the January consumer price index data showed that headlined inflation rose 2.5% on an annual basis in January, up from 2.1% previously and beating estimates of 2.4%. Core inflation, which strips the volatile food and energy prices also increased above the 2% threshold, rising 2.3% in January, from 2.2% in December and above estimates of 2.1%.
The Fed Chair said that the FOMC members would continue to assess the economic developments and take a call on whether it would be appropriate to hike interest rates or not. This comment briefly sent the expectations for a March rate hike from 17% to about 26%, tracked the CME Group’s Fed fund futures tool and increased to 41% for May and 45.8% for June.
