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From the Floor: Attention swings to ECB after dovish Yellen

  • Yellen repeats dovish message in second day of testimony to Congress
  • • Dovishness from the Fed chief helped sustain risk appetite
  • • Attention swings to July 20 ECB governing council meeting
  • • ECB's Draghi likely to wax dovish to prevent itchy trigger-finger signals: Hardy
  • • Oil boxed into $44-47/barrel range
  • • Volatility seen in government bond markets
  • •  Eyes on US June retail sales and CPI on Friday
  • • Morning call pauses for summer break -- back July 31

Saxo Strats banner
By John Acher

A second day of dovish testimony from US Federal Reserve chief Janet Yellen on Thursday kept the risk-on rally in motion, and markets will closely examine US retail sales and CPI data on Friday for anything that could affect the Fed's gradual tightening plans. 

Yellen said it was too early to conclude whether recent soft inflation readings were a sign that inflation would fail to rise to the Fed’s 2% target and that the Fed remains on track to keep raising interest rates at a gradual pace.

Attention now swings to the European Central Bank's policy meeting next week.

"After the tremendous back-up in the euro, we can expect Mr Draghi and Company to wax as dovish as possible to prevent any further impression that they have an itchy trigger finger on unwinding policy,” says Saxo Bank's FX strategy chief John J Hardy. 

“Our view is that any unwinding is going to require that the recovery is sustained post the German election when the EU political scene shapes up enough to see serious changes to the EU framework before the ECB does anything – so limited ability to get euro upside off this,” Hardy says.

Yellen's testimony to the US Senate banking committee on Thursday was largely a repeat of her performance on Wednesday, indicating that the Fed is sticking to a path of gradual tightening and that the Fed is not particularly worried about financial stability.

“We did see the Fed’s Brainard mentioning financial stability, but Yellen entirely failed to do so, and that is one of the reasons for the enthusiastic signal for risk appetite,” Hardy says.

“The Fed is seen as being dovish and not caring about financial markets for now bulling to new highs, so we have a strong response in asset markets, and it has been very strong for carry trades,” says Hardy.

The strength in carry trades is likely to last as long as risk appetite remains high, Hardy adds.

A reversal in EURGBP was strongly rejected, suggesting it will stay stuck in the range, Hardy says.

Reversal was a strong rejection of break higher 
Source: Saxo Bank

Government bonds had a bumpy day on Thursday.

“There is a bit of volatility in fixed-income market at the moment,” says Saxo Bank’s fixed-income trader Michael Boye.

Government bonds rallied on Thursday, with the 10-year bund yield falling 5 basis points, but that was entirely reversed after news that ECB president Mario Draghi will speak at the Fed's Jackson Hole conference in late August.

“What the market is reading into this is that Draghi could be preparing the markets for further tapering, which could potentially be announced at the September ECB meeting just two weeks after the Jackson Hole meeting,” says Boye.

US core CPI will direct sentiment in the bond markets today.

“The index has been dropping every month this year since the January high, and this is obviously what has led to the softened inflation outlook and yields taking a step back as well,” says Boye.

“So we’ll see if we can buck that trend. The expectation is an unchanged 1.7% [rise] for the core CPI,” Boye says.

US core CPI

US Core CPISource: Bloomberg 

Oil boxed in

Oil remains stuck in its range after a week of mixed signals.

“We are seeing the oil market continue to be boxed in,” says Saxo Bank's commodities strategy chief Ole Hansen, pointing to a $44-47/barrel range that has developed for WTI crude over the past couple of weeks.

“We did actually have a positive week, which I suppose is reasonably good considering the mixed signals we have had this week,” Hansen says.

The International Energy Agency said on Thursday that demand growth has been stronger than expected, but Opec’s production rose to the highest level for this year in June and compliance among its members with agreed production cuts has dwindled.

“We have seen some short-covering this week – the shorts are still quite elevated – but I think we are unlikely to see any acceleration in short-covering unless we break above key levels, which are basically the previous highs, $47.30 in WTI and $50 on Brent. So these are really the levels to look out for into next week,” Hansen says.

Gold short-sellers have been getting squeezed this week on indications in Yellen’s dovish performance that rates will stay low for longer, Hansen says.

Gold failed to test resistance at $1,230/oz, and that is the level that needs to be broken to see the market return to a neutral stance, while silver would need a break above $16.20/oz to ease the negative bias, Hansen says.

The Saxo strategy team's morning call now takes a two-week summer break, and will return on July 31.

Jackson Hole, Wyoming
 Jackson Hole, Wyoming, where the ECB president is slated to speak 
at a Fed conference in August. Photo: Shutterstock

John Acher is a consulting editor at TradingFloor


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