Euro: Hawkish Fed keeps gains contained against US Dollar – Commerzbank

Thu Lan Nguyen at Commerzbank notes that EUR/USD has traded in a narrow range and appears largely unaffected by Iran-related headlines, as the correlation with Oil has weakened. She highlights that markets now price Fed rate hikes despite softer labour data, reflecting a hawkish FOMC bias and reduced perceived risk of politically driven monetary easing in the United States.

Fed reaction function supports Dollar

"EUR/USD appears largely unaffected by the latest developments in the Iran conflict and continues to trade in a relatively narrow range. We had already pointed out that the correlation between the exchange rate and the oil price has diminished significantly."

"In other words, the market is now pricing in Fed rate hikes even in spite of a marked decline in oil prices."

"The fact that rate-hike expectations in the market are nevertheless holding up is mainly linked to a general reassessment of the Fed’s reaction function. And this can be traced back to the latest FOMC meeting, the first under the leadership of new Fed Chair Kevin Warsh which highlighted two points:"

"A significant number of FOMC members have a bias towards rate hikes. This was confirmed once again by the minutes of the meeting published yesterday evening, which state "Participants generally assessed that information received over the intermeeting period suggested that upside risks to price stability remained elevated while downside risks to achieving maximum employment had moderated a bit." as well as "In such scenarios [of elevated inflation], almost all of these participants indicated that some policy firming would likely be warranted to return inflation to 2 percent."."