Currencies: "Is the Janet and Mario Show a New Episode or Rerun? "

From Marc to Market:

The event that investors have been waiting for and the media frequently linked to whatever price action has taken place has arrived: Yellen and Draghi's speeches later today. Yellen is first. She will speak at 10:00 am ET. This is toward the end of the European trading week. Draghi speaks late in the North American session--3:00 pm ET.

Much of the media's coverage seems to be playing up expectations that one or both officials will provide new insight into the likely outcome of next month's policy meetings. We are less sanguine. There may be little that Yellen can contribute to investors' information set, and there may be little that Draghi is willing to reveal.

As an interpretative point, we give a privileged place to the communication of the Fed's leadership, Yellen, Fischer, and Dudley. Dudley recent comments were very clear. They were consistent with Yellen's testimony before Congress last month. Surveys suggest that market participants have taken it on board. Next month the Federal Reserve will announce that it will begin allowing its balance sheet to shrink. The expectation for a rate hike in September, which was never very high, could not get much lower.

We think that the odds of a rate hike before the end of the year is higher than one-in-three chance that is being discounted by the markets. We understand the comments from the Fed's leadership to be putting more emphasis its third mandate, financial stability, as signaling a low bar for a rate hike. Dudley suggested that he could favor a rate hike by the end of the year provided the economy does what the Fed expects. This sounds as if provided there are no significant downside shocks would be sufficient. It seems that as long as measures of inflation and inflation expectations do not deteriorate further, a rate hike would be seen as appropriate.

The Fed has judged that the economic conditions warranted the removal of some accommodation. It has been gradually lifting the Fed funds target as it operationalized its judgment. The omnipresent market has neutralized the Fed by easing financial conditions. The Fed sticks to its assessment, and this was clear to us in the FOMC minutes where the concern about asset prices was raised a notch.

There might not be anything that Yellen will likely say about the conduct of US monetary policy, which in any event does not necessarily fit well with the topic of the symposium. Draghi, on the other hand, likely has an information set that the markets don't, but he not likely disposed to share it, even if he found a way to make the nuances of ECB monetary policy the subject of "Fostering a Global Dynamic Economy."

Investors generally expect ECB policy to continue to normalize. Arguments that divergence is over seem to be exaggerating the pace of normalization. It is not just about the asset purchase program, though we point out that the ECB's balance sheet is far from peaking. With conservative but reasonable assumptions, the balance sheet will expand by more than 400 bln euros by the middle of next year. The ECB's extraordinary measures include the minus 40 bp deposit rate. How many times will the Fed raise its target before the deposit rate is no longer negative?

If the US financial conditions have eased in defiance of the Fed, the financial conditions in the eurozone have tightened more than is arguably desirable. While growth is likely to ratchet down slightly after a strong first half, the tightening of financial conditions has barely bitten. This includes the euro's appreciation, which the recent flash PMI showed has not deterred strong export orders.

That said, the euro's appreciation may help dampen price increases. Next week, the flash August CPI figures will be announced.....MORE