Financial markets have been on cruise control for a number of weeks believing that the Janet Yellen chaired Federal Reserve is dovish and will keep interest rates low for a very long period of time. Furthermore, many investors believed such a dovish Fed would help deliver outsized returns from risky assets. We believe that the broader FOMC is more divided than has been seen for a very long time, with the regional Governors now believing that policy has to be normalised. After her recent testimony, it appears that Yellen is also looking to raise interest rates sooner and faster IF the employment data continues to improve faster than her expectations.

To be clear, the FOMC will not change policy this week. They will reduce QE by US$10 billion and confirm that QE will end in October. The key issue for markets will be what Yellen says about the future path of interest rates. If Yellen is dovish, then it is likely that markets continue to trend higher with low volatility. If Yellen seems to be moving towards a more hawkish position, then markets may need to adjust. Such an adjustment should see a stronger Dollar, higher short dated yields and possibly lower equity markets around the world.

The US Dollar is definitely showing signs of life against other major currencies, trading at its best level for 6 months. This strength is most obvious against the Euro (as can be seen in the chart below) which should not be too surprising considering the new ECB policy mix. However, the US Dollar is more than holding its own against the likes of the commodity currencies and even against the recently rampant Sterling.