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Yellen testimony to pose risk to the greenback

Janet Yellen
Source: Federal Reserve | Flickr
Janet Yellen

Janet Yellen, nominated as the next Federal Reserve chief, poses a clear risk to the U.S. dollar outlook as her dovish stance could push out expectations for a scaling back of the Fed's monetary stimulus, analysts say.

In a statement released ahead of Yellen's confirmation hearing before the Senate Banking Committee on Thursday, she conveyed a dovish tone. While she noted that the U.S. economy had made progress, she also voiced her concern over the unemployment rate being too high at 7.3 percent and said inflation remained below the Fed's 2 percent target.

(Read More: Could Fed's Yellen sound like a hawk?)

Analysts said her dovish stance should keep pressure on the greenback, but her performance under questioning could provide some volatility.

"The market has been adrift lately, and probably drifted too far towards fearing tighter U.S. policy. I think we are going to drift the other way now and we will see weakness in the U.S. dollar to replace its strength seen over the last two weeks," said Greg Gibbs, currency strategist at Royal Bank of Scotland.

The dollar index, which measures the greenback's value against other major currencies, slipped 0.5 percent on Wednesday to 80.793, following near three weeks of renewed strength.

(Read More: Expect taper in the next couple of months: Morgan Stanley

According to Hamish Pepper, vice president and currency strategist at Barclays, Yellen's confirmation speech should reaffirm bearish views on the dollar, especially as many people had not expected her to have been quite so dovish in her statement, he said.

Yellen is well known for her dovish views, including her preference for low interest rates and her support of quantitative easing. She is widely expected to continue the Fed's asset purchase program for longer than other candidates might have done.

"Yellen's statement was probably seen as more dovish than the market had been expecting. …What people had been thinking[is that] when Yellen assumes the role of Fed chair next year she will be less dovish because she will be presenting the wider committee," said Pepper.

(Read more: What to watch for in the Yellen hearing: El-Erian)

"Her statement last night doesn't suggest that will be the case, and if we get confirmation this evening, essentially that is negative for the dollar," he said, adding that he forecasts tapering to start in March.

Analysts don't expect her to make any bold statements in her carefully scripted speech, but all eyes will be on the tougher grilling she receives in the follow up question and answer session.

Any suggestion that she might be slightly more dovish or hawkish than she has made her self out to be in her statement could make waves, analysts say.

"On Thursday we will get a chance to see how she handles herself live in an environment where she could find herself heavily criticized for her soft views on inflation," said Kathy Lien, managing director at BK Asset Management. "Being in the hot seat is never easy and investors will be watching carefully to see if she wavers in her views or ends up sounding more moderate under heavy grilling by U.S. Senators."

(Read More: De-crowning the dollar, and the 'collapse' ahead)

The greenback has seen wild swings this year as markets attempt to decipher just when the Fed could cut back its $85-billion-a-month bond-buying program.

Central bankers have long argued they would only taper if the economy is strong enough to withstand it. As a result, positive economic data has prompted fears of tapering and a stronger dollar, while weaker data has pushed expectations out and weakened the greenback.

—By CNBC's Katie Holliday. Follow her on Twitter @hollidaykatie

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