US DOLLAR

The performance of the dollar this past week can be partially attributed to better U.S. data as the trade balance narrowed slightly, jobless claims fell and import prices increased. Consumer sentiment however soured in the month of February with the University of Michigan index dropping to 95.7 from 98.5. The dollar was actually pressure for most of the week but recovered strongly after President Trump said he will announce “something phenomenal on taxes in 1-2 weeks.” These were the very same promises that drove the dollar sharply higher after the election so it is no surprise that investors were excited about their prospect. Does this remove the risk of a deeper correction in the U.S. dollar? No but it is a welcome distraction from the President’s attempts to talk down the currency. While we can’t forget that one of President Trump’s main policy goals is to strong arm other countries into strengthening their currencies, for the time being the market has found an excuse to revisit the Trump trade and this sentiment could last through the new trading week.

With that in mind, the dollar will remain in control of currency market flows in the coming week with Janet Yellen delivering her first semi-annual testimony on the economy and monetary policy since Donald Trump became President of the United States. As the most important event risk on the calendar, investors will be listening in closely for her views on the economy and plans for tightening. We know from the last Federal Reserve meeting that U.S. policymakers are optimistic about the labor market, consumer spending and sentiment. However they also believed that inflation is low and business investment soft. At the end of the year, Yellen seemed to support the idea of 3 rate hikes in 2017 but Fed fund futures are only pencilling in 2 rounds of tightening. Data has been mixed giving us very little guidance on which way the Fed chair will swing. If she is unambiguously positive and expresses her commitment to raising interest rates a few times this year, dollar bulls will take the greenback higher, driving USD/JPY through 114.00. However if there’s even a hint of greater caution in her voice and she over weights the uncertainty of fiscal policy, USD/JPY could slip back down to 112.

Of course USD/JPY won’t be the only currency affected as the greenback is likely to move strongly in one direction against all major currencies. While Yellen’s views will have the most significant impact on the dollar, consumer prices, retail sales, the Philadelphia Fed manufacturing index, housing starts and building permits are also scheduled for release. Consumer spending was very strong in the month of December but the data was far from stellar because excluding autos and gas purchases, retail sales was flat – we’ll need to a see a pickup on this front to support the case for March tightening.