The dollar lost ground following Powell’s comments with monetary tightening expectations scaled back slightly with the dollar index at 5-week lows.

Rhetoric from Fed Chair Powell was slightly less hawkish than expected on a potential shrinking of the balance sheet. Risk appetite strengthened following Powell’s comments despite underlying Omicron uncertainty.

Wall Street equities posted net gains as market interest rate speculation was less frantic. US bond yields retreated from peak levels during the day.

The dollar lost ground following Powell’s comments with monetary tightening expectations scaled back slightly with the dollar index at 5-week lows. EUR/USD moved above 1.1350 despite mixed ECB rhetoric. Sterling held firm with GBP/USD with fresh 2-month highs above 1.3600. Commodity currencies posted strong gains with higher oil prices and Band of Canada tightening expectations boosting the Canadian dollar.

ECB President Lagarde stated on Tuesday that the bank takes concerns over rising prices very seriously and that people can trust that our commitment to price stability is unwavering. New Bundesbank head Nagel also stated that the inflation surge is not entirely due to temporary factors and that the outlook is extraordinarily uncertain.

ECB chief economist Lane, however, commented that inflation would retreat later this year and be below the central bank’s 2% target in 2023 and 2024. He added that there was no sign of core inflation speeding up in wages settlements and that a rate increase in 2022 remains very improbable.

The US NFIB small-business confidence index strengthened to 98.9 for December from 98.4 previously and slightly above expectations while there was evidence of a marginal decline in inflation pressures. EUR/USD drifted lower into the New York open, although it held above the 1.1300 level as underlying selling remained subdued.

Fed Chair Powell stated that the economy no longer requires an extremely accommodative policy and the central bank will return to a more normal policy with inflationary pressures likely to persist until the middle of this year. There were further expectations of a near-term rate hike in March and at least three increases in 2022.

He added that the Fed will shrink the balance sheet more quickly than last time, although he still expressed caution with comments that a reduction in the balance sheet might start this year. The comments were slightly less hawkish than had been expected following the Fed minutes released last week and the dollar lost ground. Commodity currencies posted net gains with EUR/USD moving above the 1.1350 level.

The latest CPI data will be released on Wednesday and the dollar may strengthen if the headline rate is above 7.0% while a weaker release would curb US support.

The dollar was unable to regain traction ahead of the data and EUR/USD secured a net gain to 1.1375 before stalling with commodity currencies edging higher.

Atlanta Fed President Bostic stated that there is a risk that inflation will be elevated for an extended period of time and the Fed needs to respond directly, clearly and aggressively. He added that March would be a reasonable time to start hiking rates and he expects at least rate increases this year.

Kansas City Head George stated that it will be appropriate to move earlier on shrinking the balance sheet while Cleveland President Mester commented that she would back a March rate hike to fight inflation. The dollar posted net gains into the New York open with a USD/JPY peak close to 115.70.

Treasuries were marginally higher following Powell’s comments and yields edged lower while equities posted limited net gains with USD/JPY retreating to below 115.50.

Japan’s manufacturing Tankan index retreated to 17 for January from 22 previously, but the non-manufacturing index strengthened to a 23-month high.

China’s CPI inflation rate declined to 1.5% from 2.3% and below market expectations of 1.7% which increased expectations of a central bank interest rate cut and helped underpin risk appetite. Asian equities secured a limited advance and USD/JPY consolidated around 115.35 with EUR/JPY around 131.20.

GBP/USD pushed above the 1.3600 in early Europe on Tuesday but was unable to sustain the move and retreated into the New York open.

Underlying Sterling sentiment held firm on higher money-market yields and hopes that UK coronavirus cases are close to peaking. There has, however, been a strong advance since the beginning of the year and the currency struggled to gain further traction with higher yields seen as priced in.

The on-going difficulties surrounding Prime Minister Johnson had only a limited impact, but political developments will be watched closely amid frenetic speculation.

Global risk appetite held steady on Wednesday which helped underpin Sterling and overall currency sentiment held firm. GBP/USD advanced to fresh 2-month highs near 1.3650 before stabilising while GBP/EUR traded above the 1.2000 level.

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