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From the Floor: Dovish Yellen sparks broad risk-on rally — SaxoStrats

• Yellen's surprisingly dovish testimony to Congress ignites rally
• Yellen stance stokes 'Goldilocks' central bank policy convergence trade: Hardy
• USD weakens, stocks climb, gold bounces on Fed chief's dovishness
• Bank of Canada hikes to 0.75% as expected, keeps CAD on the bid
• AUDUSD could be headed for a break towards 0.80-0.81: Hardy
• Gold up on short squeeze; oil mired in mixed signals

Saxo Strats banner
By John Acher

A surprisingly dovish message from US Federal Reserve chief Janet Yellen on Wednesday ignited a broad cross-asset rally and softened the dollar.

“So it was basically the maximum, risk-on Goldilocks trade yesterday. We had basically all asset classes higher yesterday,” says Saxo Bank's equities strategy chief Peter Garnry. "I think the key message was that rates will not have to rise all that much further."

Yellen's tame remarks in her semi-annual testimony to Congress, which continues on Thursday, came as a surprise after the Fed attempted at its June meeting to stay on the hawkish side of expectations, says Saxo's FX strategy chief John J Hardy.

”There was no mention really of financial stability in the testimony, and it just leaves the impression that they want to maintain the very cautious and slow unwinding, which was already priced in any way," Hardy says. (Read also Hardy's latest FX Update here on TradingFloor.)


Perhaps the Fed is worried that it doesn’t know what the actual quantitative tightening is going to mean, and wants to get past that point before sending any signals, Hardy says. "In any case, it has the luxury to do so as long as inflation is very low."

"It really encourages what I have been calling the Goldilocks trade," Hardy says. With the Fed unwinding but other central banks starting to come around now, the Goldilocks trade is a central bank policy convergence trade, he adds. (A new video with Hardy's comments on the effects of Yellen's testimony is available here on TradingFloor.

"And the Fed unwinding so slowly that it is not really tightening conditions notably," Hardy says, "and that means putting on maximum risk, so we are seeing US stocks rebounding really rapidly and looking actually towards the highs of the cycle."

"I think that is going to be expressed in strong emerging-market currencies, strong commodity currencies, maybe a little bit less interest in the euro, and some of the interest switching elsewhere," Hardy says.

Hardy highlighted the Aussie dollar as one currency on the move.

"I don’t like the long-term outlook for the economy in Australia – especially housing – but for now, with this Goldilocks trade and the idea that the near-term indicators are turning around, commodity prices etcetera for Australia, we could see a break here and trading up to something like 0.80-0.81 for Aussie-dollar, which would see it playing a bit of catch-up with the Canadian dollar," Hardy says.

0.7750 is a big level for AUDUSD, but the latest weekly bar and the reversal of the tactically bearish prior week’s reversal is a sign that the risk side is higher for that pair, says Hardy.

AUDUSD aiming higher
Source: Saxo Bank 

Chinese trade data overnight was strong, and some of the Australian data recently have been looking up, Hardy says.

The Bank of Canada raised interest rates as expected to 0.75% on Wednesday, and its policymakers' remarks kept CAD on the bid after the rate announcement.

USDCAD drops as CAD strengthens
Source: Saxo Bank

Emerging markets are likely to be bid both in equities and currencies, says Garnry. “And that always makes it a very interesting trade because you get the best of both worlds.”

EM equities rose 1.9% on Wednesday, he notes.

Reapproaching highs

“We are getting very close to that top formation that we had in the start of 2015 in Q2 before we got the meltdown in the oil price, commodities, prices in general," Garnry says.

“So a really interesting breakout, and it looks really bid here, and also S&P500 futures are very few inches from new highs,” he says. “And if we go to new highs in the S&P 500 with the current outlook from the Fed, I would not be surprised to see another leg in this rally." 

The response in Asia has also been good, with recent Chinese data looking solid, he adds.

Garnry says the Fed apparently does not see the recent weakening in the PCE core inflation as something to be worried about.

Yellen mentioned two sources of potential headwinds: mobile phone planned subscriptions and prescription drugs face headwinds now, and that is feeding into inflation.

Generally the Fed is puzzled about the inflation picture, Garnry says.

Taiwanese semiconductor group TSMC's earnings missed analyst estimates on currency weakness and demand weakness, but the company said demand is stabilising after last year’s slump. As much of 17% of the company’s revenue comes from Apple, so the TSMC outlook will affect Apple sentiment .

“So look for Apple today, it will definitely respond to this outlook,” Garnry says.

Major US banks JPMorgan, Wells Fargo and Citigroup are slated to report quarterly results on Friday. “So any re-positioning or positioning ahead of those earnings releases should be done in today’s session – that’s very important,” says Garnry.

All three banks have negative total scores in Saxo Bank’s quant model, and US banks in general are much more expensive than peers in Europe and Asia. “They have lower yields, but a little bit higher quality and a bit better price formation recently.”

“Technically speaking Citigroup shares look the most interesting going into this earnings season, Wells Fargo has gone completely flat," Garnry says.

Garnry will hold an equities webinar at 1330 CET (1130 GMT)(Sign up here on TradingFloor.)

Gold’s pleasure

“Yellen’s comments yesterday were on the dovish side, and gold took some pleasure from that – we did see some additional short-covering,” says Saxo Bank’s commodities strategy chief Ole Hansen. (A new video with Hansen's comments on gold is available here on TradingFloor.

“The inflation uncertainty and modest growth comments also helped send the dollar and bond yields lower – these remain some of the key drivers,” Hansen says.

Gold is back above $1,230/oz after failing to break below $1,215/oz, and there still could be some more short-selling to come, Hansen says.

A break above $1,230/oz in gold, the recent high, and $16.20/oz in silver, would likely send the markets for those two metals back to neutral, Hansen says.

The US Energy Information Administration report on Wednesday was a mixed bag, showing another bullish inventory drop, but that was offset by a jump in US production to its highest level since July 2015.

“So the market took most of the rally ahead of the announcement, and we saw a drift lower afterwards.

Opec said it sees the market oversupplied throughout 2018 and they lowered the demand outlook for its own oil due to rising non-Opec production.

“Traders are fading rallies ahead of $47 in WTI and $50 in Brent,” says Hansen. “I think that remains the strategy until we eventually see a break, but it is difficult to see that break happening any time soon with the data as mixed as they are.”

Gold prices up on short squeeze
Gold price
Source: Saxo Bank

US Capitol in Washington
US Capitol building where Fed chief Janet Yellen's semi-annual 
testimony continues on Thursday for a second day. Photo: Shutterstock 

John Acher is a consulting editor at TradingFloor


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