Volatility remained very high on Tuesday with Omicron uncertainty amplified by month-end position adjustment and Fed rhetoric.

Volatility remained very high on Tuesday with Omicron uncertainty amplified by month-end position adjustment and Fed rhetoric.

Comments from Fed Chair Powell were more hawkish than expected with a warning over inflation and comments that the Fed would discuss tightening policy more quickly. Risk appetite dipped sharply after Powell’s comments with a slide in US equities.

Longer-term US bond yields, however, drifted lower. Risk appetite strengthened in Asia amid hopes that vaccines would remain effective.

The dollar recovered strongly following Powell’s comments, but failed to hold gains. EUR/USD dipped from 2-week highs at 1.1380 to below 1.1300 before settling around 1.1330 on Wednesday. GBP/USD dipped to fresh 2021 lows at 1.3200 before recovering to above 1.3300 as the dollar faded again.

Commodity currencies also retreated sharply following Powell’s comments before recovering ground. Better than expected Australian GDP data also helped trigger a recovery in the Australian dollar. Oil prices dipped sharply to 3-month lows on renewed demand fears before a tentative recovery on Wednesday.

German unemployment declined 34,000 for November after a 39,000 the previous month and larger than the expected decline of 25,000 with the labour market tight.

The Euro-zone headline CPI inflation rate increased to a record high of 4.9% for November from 4.1% previously and well above consensus forecasts of 4.5%. The underlying rate increased to 2.6% from 2.0%, above expectations of 2.3%, and the highest reading since February 2008.

The data provided an element of Euro support, although markets were still expecting that the ECB would push back against any pressure to raise interest rates. With the dollar generally on the defensive EUR/USD strengthened to 10-day highs just above 1.1380 ahead of the New York open.

In testimony to Congress, Fed Chair Powell stated that the Fed’s inflation test has been clearly met and that the possibility of higher inflation has increased. He added that it is a good time to retire the term transitory in relation to inflation and that the Fed will use all the tools to make sure higher inflation does not become entrenched.

As far as monetary policy is concerned, Powell commented that it was reasonable to consider wrapping up tapering a few months earlier and the Fed will talk about speeding up the taper at the December meeting. On coronavirus, Powell stated that more would be known about the Omicron risks in in the next week to 10 days.

The overall rhetoric was significantly more hawkish than expected, especially as markets had expected a more cautious tone given the Omicron uncertainties.

The dollar posted strong gains following the comments with EUR/USD dipping below the 1.1300 level. The US currency, however, was unable to sustain the advance and EUR/USD recovered to around 1.1335 on Wednesday as commodity currencies rebounded with markets continuing to watch Omicron headlines closely.

Risk conditions continued to be monitored closely with sentiment sapped by reports that antibody drug treatments would be less effective against Omicron. After finding support close to 112.50, USD/JPY recovered from 7-week lows and stabilised early in New York.

US consumer confidence retreated to 109.5 for November from a revised 111.6 previously and the lowest reading since February with consumers also less confident over income and employment prospects. The Chicago PMI index retreated to a 9-month low of 61.8 for November from 68.4 while inflation pressures remained strong.

The dollar posted strong gains following Powell’s comment with a USD/JPY spike to highs around 113.70. Long-term yields, however, retreated quickly and equities moved sharply lower. In this environment, USD/JPY retreated back to near 113.15 as the yen continued to secure defensive support.

Risk appetite recovered on Wednesday with some optimism that existing vaccines would be effective, although uncertainty remained intense. Chinese PMI data was slightly weaker than expected with the Caixin manufacturing index at 49.9 from 50.6 previously. Equities posted net gains and USD/JPY traded just below 113.50.

Bank of England MPC member Mann stated that Omicron will trigger question marks over consumer confidence and could undermine demand for services. She also noted that inflation pressures could intensify, especially if there are renewed supply-chain issues. Mann added, however, that it is premature to talk about rate hikes let alone the magnitude of any rate increase which certainly did not suggest support for a near-term move to raise rates.

Given uncertainty surrounding the Omicron variant, there was further speculation that the Bank of England would decide against a rate increase at the December policy meeting which limited Sterling support. The currency did gain brief support from a recovery in risk appetite, but equities tumbled again following Powell’s comments.

The firmer tone in risk appetite helped underpin Sterling on Wednesday with further very choppy trading continuing while the fresh push for aggressive vaccination also provided an element of relief.

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