After the closing bell on Wednesday, the Federal Reserve published the
prepared remarks of Fed Vice Chair Janet Yellen, which she will give during her confirmation hearing before the Senate Banking Committee today.
Markets instantly jumped after the remarks came out, which appears to mean markets are interpreting it as particularly dovish.
Rashique Rahman, Morgan Stanley’s Co-Head of Global FXEM Strategy, thinks that investors should be selling this rally as it is likely to be short-lived.
Fade the dovish Yellen Fed. Dovish comments from Yellen at tonight’s confirmation hearing could cause a short-lived kneejerk rally in EM risk. After all, price action and sentiment have been poor recently and long USD positioning has, to some extent, built up again. However, there are plenty of reasons why dovish comments from the (expected) incoming Fed Chair Janet Yellen are unlikely to prove a catalyst for a sustainable rally in EM risk and we continue to take a cautious stance on the market — particularly EM credit and FX.
First of all, the market is expecting her comments to be dovish, and the risk may be that she does not surpass these expectations in the Q&A session of tonight’s confirmation hearing. Second, we have never believed that dovish Fed policy was enough to spark a sustained rally in EM risk — particularly when it comes to FX. Without a macro recovery, and preferably one led by a recovery in exports, it will be difficult for EM to sustain gains on the back of dovish Fed policy alone.
Finally, and perhaps most importantly, should the Fed decide to change the way in which it applies any given level of stimulus that it thinks is appropriate, and focus on forward guidance instead of asset purchases, then this could still spell bad news for EM. This is in spite of whether the Fed becomes much more dovish, given the possible implications of this on longer end of the US Treasury curve.
In short, we recommend fading any rally inspired by a dovish Fed. In addition to those currencies held back by large external deficits, we are currently focused on long USD/RUB positions and expect the cross to test highs around 33.50 before year-end.
Yellen’s confirmation hearing starts at 10:00 a.m. ET.