Yellen testimony: more hawkish but still dovish

Yesterday both equity and bond markets reacted quite positively to the testimony given by Jane Yellen to the Senate Banking Committee, where the FED, although remaining very cautious and vague, did open the door for an interest rate hike this year. The European stocks rallied in the late part of the afternoon session, with the Euro Stoxx 600 closing the day up 0.56% and the FTSE 100 also up 0.71%. US equity indexes followed suit trading in positive territory and posting moderate gains.

Yellen’s remarks yesterday afternoon marked her first firm stance that interest rates in the US will be rising, and it is now a question of when more than a matter or if. However, she was very careful not to specify the magnitude of the increase or the rapidity of future hikes. Once again the FED pointed out how the US economy is clearly on track to a full recovery, with Yellen signaling that the Central Bank might be dropping the pledge to be “patient” and calling for investors to start basing their predictions on actual economic data rather than a strong forward guidance.

In this regards the FED reiterate the improvement in the labor market and the better overall economic activity, which would support the argument for an interest rate increase, however it also hint that any interest rates hike will be largely linked to wage growth rather and simply to a continuous increase in jobs’ creation. This stance is not surprising considering that the US Central Bank’s second mandate after full employment is price stability, and Yellen stated that the current US inflation is indeed lower than the bank would have liked. In fact, if on one hand low oil prices have left more money in consumers’ pockets and provided an indirect support for the whole economy, on the other hand it has also been the major drag on inflation readings, along with a strong dollar. In my opinion, inflation and a stronger dollar are the two major obstacles to an early rate increase, which would exacerbate the divergence between the large majority of Central Banks around the world, in the process of easing monetary policies and devaluating their respective currencies, and the FED, facing a strengthening dollar and about to embark onto the first monetary tightening since the financial crisis.

In conclusion, Yellen made her best to balance small hawkish comments, while remaining overall more accommodative that some analysts had anticipated, prompting markets to bet that the coming interest rate will actually be postpone to the second half of the year, most likely to September-October.

The result of this overall still dovish approach was a rise in Government Bonds’ prices across the globe, from US Treasuries to German Bunds to Australian Government bonds, pushing yields lower and reverting a trend witnessed during the last few days.

The Dollar also retreat, with investors pricing in the fact that interest rate’s discussions will be put on hold for a couple of FED’s meetings. On the back of yesterday comments, the Dollar Spot Index lost 0.2% and it is now poised for the first monthly fall since June 2014.