A Tale of Two Central Banks: Perfunctory( FED) vs. Actionable( BOC)

A Tale of Two Central Banks: Perfunctory( FED) vs. Actionable( BOC)

While nothing groundbreaking in Chair Yellen perfunctory testimony, she unambiguously drew attention to inflation as the critical determinant of Fed rate hikes. Given the market’s tepid inflation expectations, traders quickly repriced an even more cautious rate hike cycle as Dec odds fell to 50% from ~70% on the view that her written testimony was dovish..Forex traders immediately reached for yield while equity markets took flight on the dovish Fed expectation. Nothing better for investment sentiment than Dr Yellen providing an upbeat economic assessment with a tepid inflation outlook. One of those days you can have your cake and eat it.

Equity markets were not all that took flight, the Loonie ( Canadian Dollar) soared after Bank of Canada Governor Poloz delivered an unexpectedly “ hawkish “ hike that increased the odds dramatically for a longer rate hike cycle.Traders will view this as very hawkish and should be more inclined to leg into long CAD while institutional investors might flock to CAD  seizing the opportunity to catch a rare and actionable policy shift from a central bank.With a little help from WTI oil, I think the Loonie could test 1.2200 before year end.

The Carry Trade landscape had deteriorated of late on the back of the mini-bond market tantrums as a  hawkish central bank narrative was unfolding last week. However, Tuesday’s comments by Fed President Harker and Governor Brainard were broadly dovish (worrying about persistently soft inflation) saw US Treasury yields fall in response and continued to rally throughout Yellen’s congressional testimony. So the chase for yield is back on as EMFX high-yielders like TRY and ZAR outperformed on a dovish Fed outlook.

Since inflation will drive the Fed mandate, Friday’s CPI data remains exceptionally important as the USD remains particularly vulnerable to another inflationary wobble. With the Fed back in a wait-and-see mode, the enormity of Friday’s CPI print can not be overstated. If the data produces a fourth consecutive miss, it brings into question the Fed’s contention that inflation is transitory. US yields would unquestionably rally, and the bond rally extension could leave the dollar in world of hurt

I think it a safe to say that if the Feds are concerned about inflation ECB will err likewise. Keeping in mind that Eurozone inflation has edged further below the European Central Bank’s target in June due to a sharp decrease in the rate of energy price inflation. And with sagging oil prices unlikely to rebound significantly higher anytime soon, traders took profits and drove the EURO below 1.1400 briefly before finding a happy medium above 1.1425 as dealers take pause for now. It’s unlikely the Euro reverse course, but traders are now awaiting the next round of ECB rhetoric.But I also think it’s safe to say the rates selloff (driven by long unwinds) is done for now.

Japanese Yen 

While the short-term picture remains uncertain as markets whip around on the back of US yields, BOJ accommodation and a high bounce in risk appetite should be supportive of USDJPY long term. But with US CPI looming I suspect dealer will be more inclined to book what every profit they’ve made but reluctant to enter dollar longs.So we’re unlikely to see too much of a bounce higher today.

Australian Dollar

The domestic calendar is very light, so the AUD is benefiting from the broader USD weakness, a bounce in risk sentiment and a jump in oil prices after a bigger than expected drop in US stockpiles are playing positively into the Aussie basket.

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Stephen Innes

Stephen Innes

Head of Trading APAC at OANDA
Stephen has over 25 years of experience in the financial markets and currently based in Singapore as the Head of Trading Asia Pacific with OANDA. Stephen's market views focus on the movement of G-10 and ASEAN Currencies. His views appear in Bloomberg, CNBC.Reuters, New York Times WSJ and the Economist. His media appearances include Bloomberg TV & Radio, BBC International, Sky TV, Channel News Asia, ASTRO AWANI and BFM Malaysia. Stephen has an extensive trading experience in Spot and Forward FX, Currency and Interest Rate Futures, Money Market Derivatives and Precious Metals. Before joining OANDA, he worked with organisations like Nat West, Chemical Bank, Garvin Guy Butler, and Sumitomo Mitsui Banking Corporation. Stephen was born in Glasgow, Scotland, and holds a Degree in Economics from the University of Western Ontario.
Stephen Innes