Janet Yellen delivers her semi-annual testimony to Congress starting Tuesday at 1400 GMT

One of the oldest trading adages is to focus one something that no one else is watching. The world is fixated on the UK and the Brexit vote on Thursday.

The Federal Reserve has faded into the background after a weak non-farm payrolls report and a wait-and-see view at the FOMC.

Still, there are questions that need to be resolved and two days of hard questioning (with plenty of grandstanding mixed in) may offer some insight into what the Fed does next.

The timing of Humphrey Hawkins is curious but she may simply be a way to stay out of conflict with the Republican and Democratic conventions.

Once bitten, twice shy

At the recent FOMC and press conference, Janet Yellen sounded like someone who had been burned. She had been convinced, at least partially, that better economic times and inflation were coming. Then a the weak jobs report rattled the narrative.

The Fed often pleads that markets shouldn't over-analyze a single data point but it's policymakers that have pulled an about-face here.

The Fed has been battered for poor forecasting before and this report was like a dagger. It seemed to rattle the FOMC and what had been a plan to hike 'in the coming months' has now been put on ice indefinitely.

...or at least that's the impression we got after the FOMC. Yellen may wish to walk that back and keep the possibility of a hike high.

At the moment, the implied probabilities in the Fed funds futures market suggest:

  • 10% of July high
  • 31.6% chance at Sept meeting
  • 33.1% in Nov
  • 46.4% in Dec
  • 48.6% in Feb

The Fed dots are still forecasting two hikes at the median but if you strip out the (largely non-voting) hawks, they've likely already given up on that idea.

Inflation view

A line in the FOMC press conference that didn't get much attention was a forecast for inflation to return to 2% "in 2-3 years". That's a long time away and it's arguable that the Fed is failing in its mandate.

The inflation hawks tend to grandstand a bit louder at Humphrey Hawkins but she may get grilled by the doves this time. She may also be asked about the Fed playbook should low inflation or an economic shock hit.

Brexit

Speak of economic shocks. A Brexit would roil markets and eliminate the chance of a Fed hike this year.

From where I stand, it would be a complete game-changer. For the purposes of the Fed and trying to understand what will happen going forward, we have to go into Yellen's testimony assuming the 'remain' side will win.

If that doesn't turn out to be the case, all bets are off.

Market movers

I think the market will be trying to gauge her overall optimism. The FOMC left a sour taste in the market's mouth and the slide in USD/JPY along with bond yields has shown that it still lingers. That problem is that it's impossible to separate from the Brexit flows.

A week from now after the Brexit hullabaloo dies off, expect a renewed focus on the Fed and the US economy. Yellen will set the tone but it's not likely to be tradable in the near term.

Illustration c/o @victorleonardib