Treasury Secretary Yellen stated that interest rates might need to rise to combat overheating.

Overall market volatility was higher during Tuesday amid an on-going debate over inflation and interest rates. Treasury Secretary Yellen stated that interest rates might need to rise to combat overheating.

The comments spooked markets with sharp declines in equities and dollar gains. Wall Street stocks posted losses led by heavy losses in the tech sector. Overall sentiment stabilised on Wednesday as Yellen added dovish comments with US equity futures higher.

The dollar failed to hold peak levels, but posted slight net gains. EUR/USD tested the 1.2000 support area. Sterling recovered ground in choppy trading with GBP/USD around 1.3900 ahead of Thursday’s BoE decision. Commodity currencies recovered from intra-day lows as equities stabilised.

The dollar was able to resist selling pressure in early Europe on Tuesday with the Euro unable to gain any fresh traction. Risk conditions were less confident into the New York open and EUR/USD drifted towards the 1.2000 area with no major Euro-zone developments.

The US goods and trade deficit widened to a record $74.4bn for March from a revised $70.5bn previously as imports increased sharply. There were underlying concerns that the deficit could damage dollar sentiment over the medium term, especially with expectations that there would be very strong import demand in the short term.

Risk appetite dipped after the Wall Street open which created an element of defensive US dollar demand. Commodity currencies posted further losses which underpinned the US currency, although EUR/USD was able to find support close to 1.2000.

US Treasury Secretary Yellen stated that interest rates might need to rise to keep the economy from overheating given the very expansionary fiscal policy. The comments triggered fresh concerns that the Fed might raise interest rates. The dollar jumped higher on the comments, but was unable to sustain the advance in choppy trading conditions and EUR/USD settled around the 1.2020 area after finding further support near 1.2000.

Subsequently, Yellen stated that she was not predicting or recommending higher rates and maintained a generally dovish stance which helped minimise any further market impact, especially as she also expected any inflation increase to be transitory. The dollar was unable to gain further traction and drifted on Wednesday with EUR/USD just above 1.2000 ahead of the US ADP jobs data.

The dollar was unable to make headway into the New York open on Tuesday and drifted lower. Equities moved lower after the New York open and US bond yields also moved lower with the 10-year yield close to 1.60%. The yen gained net support amid weaker equities and USD/JPY settled around 109.25 at the European close.

US yields failed to hold gains seen on Yellen’s comments and there were fresh losses late in the European session which sapped dollar support.

The US rate debate remained a key focus. Dallas Fed President Kaplan repeated previous comments that the open market committee should at least starting discussing the tapering of bond purchases. He also commented that businesses were less confident that inflation pressures would be transitory.

San Francisco head Daly repeated the Washington line with comments that the inflation spurt would be transitory and that a little inflation would be good for us. Minneapolis head Kashkari stated that the central bank had tools available if inflation surprises higher.

Volatility eased in Asia on Wednesday with volatility again curbed by holidays in Japan and China and USD/JPY edged higher to 109.40.

The UK manufacturing PMI index was revised marginally higher to 60.9 for the final reading from the flash figure of 60.7.

There was a decline in mortgage approvals to 82,700 for March from 87,700 the previous month and below consensus forecasts of 92,000. There was, however, a surge in mortgage lending to £11.8bn for the month from £6.2bn previously and the strongest reading of record as buyers looked to complete before the scheduled ending of the stamp-duty holiday, although this was extended in the budget. Overall lending remained subdued, however, with a further net repayment of consumer debt.

Sterling maintained a firm tone in early European trading, but gradually lost ground and dipped into the New York open as GBP/USD failed to make a fresh challenge on the 1.3900 level. A dip in equity markets also curbed support with caution ahead of Thursday’s Bank of England meeting also a factor.

There was notably choppy trading towards the European close with GBP/USD recouping losses from below 1.3850 to re-approach the 1.3900 area while GBP/EUR rallied to just below 1.1500. The Pound held steady on Wednesday as risk appetite stabilised and GBP/USD traded near 1.3900 with the GBP/EUR just above 1.1500. Expectations of hawkish Bank of England rhetoric helped underpin demand for the UK currency.

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