EUR/USD is currently attempting to stabilise around the 1.1000 mark. Fed Chair Powell has dampened expectations for rate cuts, indicating risks related to inflation and recession due to US tariffs could limit the Fed’s ability to reduce rates.
On Friday, EUR/USD remained mostly unchanged, reflecting market caution. Powell acknowledged that the US economy appears healthy, but warned of potential inflation arising from recent tariffs imposed by the Trump administration, increasing concerns about stagflation risks.
Federal Reserve’s Cautious Approach
This recent tone from Powell, measured though it was, suggests that the Federal Reserve is in no rush to pull back on monetary tightening. The reference to inflationary pressure from Trump-era tariffs isn’t just about cost-push inflation—it’s a clear warning that external price shocks still carry weight in policy discussions. Despite reassuring comments on current economic strength, the inflation outlook remains skewed to the upside. That keeps any prospect of meaningful rate reductions firmly on the backburner.
From our perspective, any assumption of swift policy easing appears misplaced. The pricing of rate-sensitive instruments will need to reflect this broader caution. We have seen that forward guidance from the Fed isn’t leaning dovish. Traders need to curb the impulse to front-run cuts based solely on improving data points. Instead, they should pay closer attention to sticky inflation indicators, particularly those linked to trade costs and supply-side constraints.
The euro’s muted response, particularly on Friday, indicates markets are still in a wait-and-see mode. However, this stability at 1.1000 doesn’t suggest comfort. Rather, it reflects compression in volatility while macro risks remain unresolved. With stagflation risks mentioned explicitly, volatility can re-emerge quickly—especially if additional tariffs or pricing pressures surface in the data.
Impact Of Monetary Policy Divergence
Short-end rates in the US could stay buoyant, which would keep the dollar supported versus the euro in the near term, absent a material recovery in the eurozone’s growth outlook. Investors on this side need to weigh the asymmetry between the ECB’s cautious optimism and the Fed’s reluctance to pivot.
It’s also worth considering positioning dynamics. The euro has struggled to gain traction, and with monetary policy likely diverging, open interest in EUR/USD derivative positions could show increased sensitivity to incoming US data, particularly on consumption and wage growth. That would indicate lower tolerance for negative surprises from Europe or dovish signals from Frankfurt.
As traders, we should re-establish sensitivity to headline risk, especially when tied directly to inflation pass-through and labour market stickiness. A broad view of tariffs and inflation needs to be integrated into rate expectations, rather than treated as temporary distortions. The Fed, by Powell’s own admission, is treating them seriously—and so should we.
Bias for the time being leans toward strength in the greenback, but that is not a certainty. As we interpret near-term volatility, skew adjustments in options markets will be more informative than spot moves. Staying nimble, while watching the data calendar closely, should be the short-term approach.
