EUR/USD failed to hold above 1.2150 and retreated sharply to below 1.2100.

The jump in bond yields on increased inflation concerns was the main focus on Tuesday. Risk appetite was slightly less buoyant during the day amid concerns that monetary support could be withdrawn earlier than expected. Wall Street gains faded late in the session with global momentum also fading.

The dollar initially retreated, but recovered from 3-week lows to post net gains as US yields moved higher. EUR/USD failed to hold above 1.2150 and retreated sharply to below 1.2100. Sterling maintained a robust tone, but GBP/USD faded from 34-month highs above 1.3950. Commodity currencies reversed initial gains and edged lower amid the firmer US dollar.

The German ZEW economic sentiment index strengthened to a 5-month high of 71.2 for February from 61.8 the previous month and above consensus forecasts of 59.6. There was, however, a slight decline in the current conditions index to -67.2 from -66.4 previously. The wider euro-zone index strengthened to 69.6 from 58.3 previously.

The dollar posted 3-week lows ahead of the New York open as underlying US sentiment remained weak and markets continued to chase reflationary trades including commodity currencies. In this environment, EUR/USD traded above 1.2150 as the dollar remained on the defensive.

The New York Empire manufacturing survey strengthened to 12.1 for February from 3.5 previously and above consensus forecasts of 6.2. There was stronger growth in new orders for the month and unfilled orders also posted an increase. Employment continued to increase on the month and there was a sharp increase in prices for the month, reinforcing expectations of a wider increase in inflation as bond-market trends remained important.

The dollar was able to regain some ground following the data and gained additional traction as Wall Street opened. Mixed data has triggered uncertainty over the US outlook and Wednesday’s retail sales data will be important for sentiment with a significant rebound expected for January.

St Louis Fed President Bullard stated that financial conditions were generally good and that inflation was likely to rise this year which is something that the central bank would take into account. The comments triggered some fresh speculation that the Fed could shift to a less accommodative policy later this year.

San Francisco head Daly stated that pressure on inflation was still downward, although markets remained pre-occupied with the inflation threat. There was a sharp dip in gold prices and the dollar also recovered strongly with EUR/USD retreat to just below 1.2100. The dollar held a firmer tone on Wednesday with the Euro retreating to 1.2080.

The dollar dipped lower ahead of the New York open with wider losses pushing USD/JPY to lows just below 105.20. There was evidence of buying on dips and the dollar secured fresh support amid a renewed increase in bond yields with the 10-year yield at 12-month highs above 1.25% while the 30-year yield moved above 2.00%.

Kansas City Fed President George stated that the single-family housing sector was very strong and this strength is expected to continue for some time. The yen overall remained on the defensive amid further short covering and USD/JPY strengthened sharply to four-month highs close to the 106.00 level just after the European close.

Japan’s monthly Tankan index strengthened to a 19-month high of 3 for February from -1 previously while pessimism in the services sector eased slightly. Exports increased 6.4% in the year to January, although this was slightly below consensus forecasts and imports decline 9.5%. Core machinery orders increased 5.2% for December compared with expectations of a 6.0% decline. Increased confidence in the outlook had little market impact.

US yields edged lower on Wednesday which curbed further yen selling and USD/JPY settled close to 106.00 from 5-month highs of 106.20 with EUR/JPY around 128.00.

Sterling maintained a firm tone on Tuesday with further support from confidence that the UK vaccination programme would allow an easing of coronavirus restrictions and help deliver a strong economic recovery. The positive tone was amplified by robust risk appetite and strong demand for reflation trades which helped underpin the UK currency. GBP/USD pushed to fresh 34-month highs just above 1.3950 as the dollar remained on the defensive.

There was an increase in volatility in US trading as the US currency recovered ground on higher yields. GBP/USD dipped sharply to lows near 1.3870, but there was still strong support on dips and a recovery back above 1.3900 while GBP/EUR rallied to 9-month highs just above the 1.1475 level.

The headline UK CPI inflation rate increased to 0.7% for January from 0.6% previously and marginally above expectations with the core rate unchanged at 1.4%.

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