- EUR/USD slumped on Wednesday and has dropped below 1.2050, weighed by strong US data.
- A dovish FOMC minutes release did not impact price action at all.
A dovish tone to the minutes of the most recent FOMC meeting, released at 19:00GMT on Wednesday did not come to the rescue of EUR/USD. The pair, which has been under pressure since prior to the start of Tuesday’s US session, is currently licking its wounds just off session lows and trading in the 1.2040s. On the day, EUR/USD trades with losses of about 0.5% or just over 60 pips on the day and the euro is one of the worse G10 FX performers on the day.
Driving the day
A 10bps rally on the week for the 10-year US government bond yield (with similar-sized rallies across other longer duration US bond yields) combined with a string of strong soft and hard US data releases covering the months of January and February are pumping the “US outperformance versus the EU” narrative. For reference, after the February NY Empire State Manufacturing Index survey on Tuesday beat consensus, Wednesday saw January Retails Sales blow expectations out of the water, while January Producer Price Inflation and Industrial Production also beat consensus.
Though, as Wednesday’s FOMC minute release reasserted, the Fed is intent on maintaining its ultra-accommodative policy for the foreseeable future, markets know that when it comes down to it, the Fed is data-dependent. In other words, if the US economy does return to full employment and inflation does get Core PCE sustainably but moderately above 2%, it will be raising rates. Current market consensus is for this to happen sometime in 2024 (hence why short-end bond yields are still close to zero). But this could happen sooner and recent strong data combined with expectations for a powerful post-Covid-19 economic recovery (sent further into overdrive by more fiscal stimulus) seems to have brought forward expectations for Fed tightening. Rather than meaning the Fed hikes rates prior to 2024, that could alternatively mean that the Fed starts tapering its asset purchase programme sooner than anticipated.
This narrative is bearish for EUR/USD given that expectations for any tightening from the ECB any time soon are pretty much at rock bottom. The EU Recovery Fund is tiny in comparison to the multiple fiscal stimulus packages already implemented in the US, implying a more sluggish post-Covid-19 recovery. Moreover, the bloc’s comparatively sluggish vaccine rollout pushes the timeline for a return to “normality” in Europe further back than in the US. There is virtual unanimous consent amongst analysts that it will be the Fed tightening policy before the ECB, the question is just how much before.
FOMC Minutes Recap
As expected, the minutes from the late January FOMC meeting were very dovish; the Committee remains willing to look through any transitory pick-up in inflation and remains focused on achieving its dual mandate of price stability (defined as getting Core PCE moderately above 2.0% for a sustained period, in line with the bank’s new average inflation targeting policy) and maximum employment, which appears to now place more emphasis on achieving full employment within disadvantaged communities within the US, not just full employment on the whole (which implies running the labour market hot).
With regards to QE tapering, the minutes said that “participants noted the importance of communicating well in advance of any change to the pace of bond purchases”. Thus, Capital Economics “doubt that the Fed will begin to taper its asset purchases until early next year and believe that the first interest rate hike will be delayed until 2024.”
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