EUR/USD drops under 1.2000 as Powell send US bond yields flying

EUR/USD has dropped sharply in recent trade to back under the 1.2000 level, down around 0.6% or around 70 pips on the day. The pair sold off amid a pickup in the US dollar following comments from the Chairman of the Federal Reserve Jerome Powell, whose remarks seemed to under-deliver on market expectations. Prior to his comments, EUR/USD was trading closer to 1.2050. Tuesday’s 1.1990 low seems to be acting as support, but a break below this area could see the EUR/USD drop back to the February low at just above 1.1950.

Driving the pickup in the US dollar has been a sharp pick up in US government bond yields; 10-year yields, which had been flat on the day prior to Powell’s remarks, are now up about 6bps to over 1.53%. 30-year yields are up about 5bps to over 2.30%. As a result of the rally in USD and US bond yields, stocks are taking a knock, with the S&P 500 now down over 1% on the day.

Fed Chair Powell speaks at the WSJ Jobs Summit

Fed Chair Jerome Powell recently finished an online conversation with Nick Timiraos, chief economics correspondent at the WSJ, at the WSJ's Jobs Summit.

In terms of his commentary on the outlook for the US economy and the outlook for interest rates and the Fed’s asset purchases programme, Fed Chair Jerome Powell stuck to the usual dovish script. To summarise Powell’s remarks, on the economy; though the outlook has brightened, the US economy remains a long way from the Fed’s goals (lots of talk about how the true jobless rate remains close to 10M) and though inflation is expected to pick up as the economy reopens and due to base effects over the coming months, Powell does not think this will constitute anything more than a transitory rise in inflation given that 1) in recent years deflationary pressures have been stronger than inflationary pressures and 2) inflation expectations remain well-anchored around 2%.

On policy; given the fact that it will take the Fed a long time to reach its goals, Powell still expects rates to remain close to zero for a long-time and the Fed will only start hiking rates once it has met its dual mandate for full employment and inflation averaging moderately above 2% for a time. On QE, Powell reiterated that the Fed will not taper asset purchases until “substantial” progress has been made towards the dual mandate.

The reason why markets have reacted as they are (i.e. bond yields spiking, the USD picking up and stocks looking heavy) is because, when pressed multiple time on how the Fed might respond/deal with “disorderly” bond market conditions, Powell refused to get drawn into talking about any specific Fed policies. He made no mention of yields curve control, weighted average maturity extension or operation “twist” and refused to talk about how the Fed might manage market functioning if the supplementary leverage ratio requirement relief that bank’s have been enjoying by banks (which means banks don’t have to hold reserves on their treasury holdings) is not extended beyond March.

Given that these are topics that other Fed members have spoken on in recent days, markets seem to have expected that Powell would also speak on these matters. Not the case. Though Powell is likely holding intense discussions on these issues with his colleagues, any final decisions on these matters (i.e. how the Fed might respond to disorderly bond markets) is yet to be made – the final decision on this is likely to be made in two weeks’ time at the upcoming FOMC meeting.