The emergence of the Omicron variant of COVID-19 has sent volatility levels soaring throughout financial markets. There was an accepted view that there was enough doubt and uncertainty over the impact of the new and more virulent form of coronavirus, that would cause central banks to be more cautious on any moves to tighten monetary policy. The hawkish response of Fed Chair Powell shattered this view. However, as markets have taken this view, the US dollar (USD) has not seen any sustained strength and could still be set to reverse. Reaction in the next few days could be pivotal for the near term outlook across markets.
- In his Congressional testimony, Powell was bordering on being explicitly hawkish
- This has not driven the USD strengthening that might have been expected.
- There are several key levels to watch on major markets that could now trigger a shift in near term outlook
A hawkish Powell shocks markets
The pre-submitted testimony of Jerome Powell suggested caution would be wise over the emergence of the Omicron variant. However, when it came to his appearance before the Senate Banking Committee, the Fed Chair completely surprised markets.
Powell said that:
“at this point the economy is strong, and inflationary pressures are higher, and it is therefore appropriate in my view to consider wrapping up the taper of our asset purchases… perhaps a few months sooner”
He continued about the taper:
“I expect that we will discuss that at our upcoming meeting” (i.e. on 14th/15th December)
As for inflation, Powell said that it is a good time to retire the “transitory” reference for inflation. Also regarding interest rates, he said that there is a three-part test for raising rates (maximum employment, inflation rising to 2% and on track to moderately exceed 2% for some time). The inflation conditions have been met. (This turns attention squarely onto the labor market, with Nonfarm Payrolls on Friday.)
With the very real prospect of the taper being accelerated, markets have since moved sharply to re-price in for earlier rate hikes. From just before the Powell testimony, with US interest rate futures (Eurodollar) struggling to price in a second rate hike by the end of 2022, there is now the potential for three rate hikes in 2022.
This did send markets into something of a tailspin as it was a departure from what had been expected to be a cautious approach by Powell. The USD strengthened again, equity markets fell and commodities sold off.
However, we have also seen that these moves have not lasted, and have seen a sizeable retracement. That leaves markets intriguingly poised.
A USD unwind is still possible from here
Market volatility on equities and forex remains elevated. The initial knee jerk reaction to the Powell testimony looked pretty damning for the prospect of recoveries that had been previously building across major forex.
However, the move has quickly unwound. The -150 pip spike lower on EUR/USD has rebounded by almost 100 pips. However, the consolidation now in place suggests that markets are unsure how to play it.
A recovery uptrend is still in place on the technicals (looking past the volatility of the knee jerk move), whilst the rising 21 period moving average (on the four-hour chart) is also a basis of support. However, the spike certainly serves as a warning now. A failure to quickly resume the move higher is unlikely to see any further traction higher in a recovery. It means that the coming session or so will be key for the near term outlook.
For EUR/USD to recover, a move above 1.3380 resistance is now a crucial test. However, as markets begin to settle in for this new outlook for the Fed, then a break back under 1.1290/1.1310 would suggest limited recovery potential, and a USD renewed strength would be likely. It would bring 1.1185 back into play again and serve to further damage the prospects of recovery on other major currencies versus the USD too. Check out our Forex page for more info on EUR/USD.
Gold is also on the brink
We also saw that this new outlook of accelerated Fed tightening pulled gold sharply lower. XAUUSD fell by -$38 in the space of a couple of hours. Breaching $1778 support into the close was a negative signal. However, the market has rebounded this morning, also holding on to the four-month uptrend.
If USD strengthens against EUR/USD (pulling it below 1.1290) then we can expect gold to also pull lower. Gold has not had a positive close of any note in almost two weeks. Every time there is a threat of an intraday rally forming, the move is snuffed out into the close.
This makes today’s early rebound more important. The move is up from a key technical inflexion point and another bull failure today would be a confirmation that the potential for recovery is seriously undermined. This looks to be a key moment for major markets. For more info on our gold, you can go to our commodities page.