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  • EUR/USD has been rangebound for most of Wednesday’s session between 1.2110-1.2140 parameters.
  • Soft US CPI data and a dovish Fed Chair Powell were not enough to trigger a breakout.

EUR/USD has been rangebound for most of Wednesday’s session, swinging between session lows in the 1.2110s but for the most part remaining capped below the 1.2140 mark. At present, the pair is trading flat on the day in the 1.2120s, with recent comments from the Chairman of the US Federal Reserve and softer than expected US Consumer Price Inflation data (released earlier in the session) both failing to trigger much by way of volatility for the pair.

US Consumer Price Inflation

The debate that is currently raging amongst economists in the US is over whether or not all the monetary stimulus currently being provided by the Fed, and the further fiscal stimulus likely to be provided by the now Democrat-controlled Congress, will cause the US economy to overheat later in 2021 or in 2022. Thus, Consumer Price Inflation data for January 2021, which was released earlier on Wednesday and refers to a period when the US economy was still suffering in the grips of the worst wave yet of Covid-19 infections (which naturally weighed on economic activity and consumer prices), is hardly relevant to the “is the US economy going to overheat?” debate.

Meanwhile, inflation data over the coming months is expected to show a marked increase in the YoY rate of price growth, a reflection of price weakness at the end of Q1 and during Q2 in 2020 (due to the extraordinary economic impact of the first Covid-19 lockdown). The Fed has already indicated that it is not going to worry about this “transitory” increase in inflation (something Fed Chair Jerome Powell reiterated on Wednesday). More important to the “is the US economy going to overheat?” debate is what happens to the MoM rate of Consumer Price Inflation in the coming months; if this shows signs of suddenly picking up, this will be a much better indicator that the economy is starting to overheat.

In terms of what all of the above means for EUR/USD; if all the fiscal and monetary stimulus does result in a US economy that “over-heats” and sees inflation rise uncomfortably beyond the Fed’s 2.0% target, then the Fed might have to step in with monetary policy tightening sooner than expected. This would likely be very bullish for the US dollar, as US real yields would rocket higher, increasing the currencies relative attractiveness versus its G10 rivals.

Conversely, if the US economy goes as planned, i.e. the economy recovers rapidly but inflation takes time to see a sustained rise and the Fed holds interest rates at near zero for at least as long as currently expected by markets, then this will be good for risk appetite and is likely to be a bad thing for the US dollar.

Fed Chair Powell speaks

Fed Chair Jerome Powell stuck to the script on Wednesday. He reaffirmed the bank’s commitment to reaching full employment, alongside the Fed’s new, more dovish pledge not to tighten monetary policy in response to a tightening of the labour market (in the past they did this to get ahead of the inflation a tight labour market was assumed to be a leading indicator of).

Powell also reaffirmed the bank’s pledge to aim to get inflation back to moderately above the 2% target for a time. The Fed Chair gave another nod to the probability that the YoY rate of inflation is set to shoot up in the coming months (as a result of weakness in prices during the first COvid-19 lockdown last year) and that this would not mean much. If inflation did rise to troubling levels, Powell said, the Fed has the tools to address this and would se them.

As a result of the fact that the bank is still some ways away from its goals (i.e. full employment and inflation), Powell reiterated, as expected, that the bank will maintain rates at current near-zero levels until the economy reaches these goals and is on track to moderately exceeds its inflation goals for some time.

With regards to the banks bond buying; Powell reiterated, as expected, that the Fed will continue purchases at the current pace until substantial further progress is made towards its maximum employment and price stability mandates. Powell later added that the bank is not thinking about shrinking its balance sheet but that, in the long run, the Fed’s balance sheet would not be bigger than it needs to be.

By sticking to the script, Fed Chair Powell seemed to contribute to a slight improvement in the market’s appetite for risk. Stocks and bond both rose in tandem, anyway, as Powell finished his speaking event without any communication gaffes.