- EUR/USD saw modest strength in wake of weak US inflation data, but remains rangebound around the 1.1900 area.
- The ECB is expected to hold policy settings steady, with the main focus on any rhetoric regarding rising bond yields.
EUR/USD currently trades flat on the day around the 1.1900 level, with sellers having come in to keep the pair from breaking above Monday’s highs in the 1.1930s. The currency pair is back to trading in its range of the last 36 or so hours, with a softer than anticipated US Consumer Price Inflation report for the month of February having failed at triggering any lasting USD weakness.
Key events in the form of Thursday’s ECB monetary policy decision and Friday’s Industrial Production data ought to give the euro side of the equation some more impetus over the next two days. More immediately and pertaining to the USD side of the EUR/USD equation, a $38B 10-year US government bond auction will be in the spotlight as the appetite for US debt at higher yields is tested. Meanwhile, Weekly Jobless Claims numbers on Thursday will, as ever, be worth watching, as will Friday’s February Producer Price Inflation report and preliminary March Michigan Consumer Sentiment Index data.
US CPI report and market reaction
Headline Consumer Price Inflation (CPI) in the US in the month of February came in at 1.7% on a YoY basis, according to the latest BLS report, inline with market expectations and an increase of January’s YoY rate of inflation of 1.4%. On a MoM basis, the CPI rose 0.4%, also in line with consensus market forecasts. However, according to the BLS report, Core CPI was softer than expected, with the YoY rate coming in at 1.3% (versus market expectations for 1.4%) and the MoM rate coming in at 0.1% (versus market expectations for 0.2%).
The increase in the headline rate of CPI was driven by a 7% MoM increase in gasoline prices in the month of February. Meanwhile, the Core measure of CPI was weighed by weakness in used vehicle, prescription drug and travel-sensitive sectors. Capital Economics find continues weakness in core prices “hard to square with the recent recovery in demand” and think that “with the high-frequency data showing that restaurant dining and air travel are now rebounding rapidly, it’s surely only a matter of time before prices in those most-affected services sectors start to pick up”. The economic consultancy concludes that “with the imminent fiscal stimulus set to turbo-charge demand, at a time when many sectors are already facing severe supply constraints, and with a variety of survey indicators pointing to rising price pressures, we still think inflation will rebound rapidly over the coming months”.
In terms of the market reaction; though weakness in USD has not persisted and initial losses have for the most part no been pared (DXY is back at 92.00 from 91.80 post-data lows), the reaction in the US stock market, in precious metals and in US government bond yields has been more long-lasting; the former two asset classes have seen strength, while bond yields have fallen.
Such a reaction is indicative of the fact that the CPI report must have eased fears of the US economy “overheating” in the coming months/years, something which is feared would lead to an earlier than anticipated Fed monetary policy tightening response. Give that expectations for Fed tightening are typically associated with lower stock, precious metal and bond prices (meaning higher bond yields), the fact that Wednesday’s CPI report has eased these fears means an opposite reaction.
ECB Monetary Policy Decision Preview
The ECB is widely expected to leave its major policy settings unchanged at Thursday’s rate decision; the deposit rate is expected to be left at -0.5%, the PEPP envelope at EUR 1.85T and the bank’s refinancing operations to be left untweaked. Focus over the last few weeks has predominantly been on the ECB’s take on and response to the recent rise in European government bond yields, which have risen in tandem with bond yields in the US and in other major developed economies (like the UK, Canada, Australia and New Zealand).
ECB speakers have already embarked on a campaign of verbal intervention, which does seem to have succeeded in slowing the rate at which yields rise (versus bond yields in the US and other places, anyway); ECB President Christine Lagarde said the bank is “closely monitoring” longer-term nominal bond yields, Chief Economist Philip Lane warned that any excessive tightening in financial conditions would be inconsistent with the bank’s goal of getting inflation back to target, while influential Governing Council Member Isabel Schnabel espoused similar concerns, arguing that a premature tightening of financial conditions may withdraw policy support too early and abruptly. More dovish ECB members have gone further, with one calling for yield curve control and another calling for an accelerated pace of asset purchases.
Thus, what the ECB says regarding the recent rise in bond yields will be the most important part of Thursday’s monetary policy statement. Similarly, expect Lagarde to be quizzed on bond yields in the press conference, as well as questioned on why the ECB has allowed the rate of net asset purchases to decline over the past two weeks, despite talk of increasing the pace of purchases/using the PEPP’s flexibility to deal with rising yields.
Note that the ECB will also issue new economic projections; staff projections are expected to remain broadly unchanged with the 2021 growth rate to be held close to 4.0% and the 2022 and 2023 growth rates likely to be left broadly unchanged at 4.2% and 4.3% respectively. Some banks think the ECB will upgrade its inflation forecasts, however, amid a stronger bounce in the YoY rate of inflation in January and rapidly rising oil prices.