The euro is in a holding pattern, awaiting cues from the ongoing French coalition talks. Potential outcomes range from a left-wing government to a market-friendly technocratic prime minister—like waiting to see if your blind date is a rocket scientist or a rock star. Meanwhile, FX volatility has been taking a nap, but several upcoming events could jolt it awake, including Powell’s testimony today and the US Consumer Price Index (CPI) release on Thursday.

Still, the EUR/USD shows more alignment with rate spread movements. Notably, the narrowing of the 2-year Eurozone-US swap spread corresponds with the recent uptick in EUR/USD. Market fears of a significant sell-off in French OATs have subsided, leading to the US yield movements' more significant influence on the pair. As we mentioned yesterday, given the streak of weak US economic data, it’s anticipated that Powell might adopt a more dovish tone in his testimony on Capitol Hill today. One could say he's more likely to be a dove cooing softly rather than a hawk screeching about rate hikes.

Thursday’s CPI data will be crucial in determining whether the probability of a September  rate cut increases further from the current 75%. With two more payroll reports and three CPI reports due before the September FOMC meeting, traders are likely to avoid heavy short dollar positions. The specter of Trump’s trade policies, viewed by FX traders through an inflationary lens, also suggests fewer Fed cuts in the future, which is dollar-supportive

However, if Powell’s comments highlight concerns about a weakening labour market, the odds of a September rate cut could rise to 90%, potentially weakening the dollar slightly. However, as I advised my FX trading colleagues this morning, it might be more strategic to play the "rate cut fever" via gold rather than currency markets. After all, even magicians need different tricks up their sleeves! In particular, shorting USD/JPY seems increasingly challenging due to entrenched carry trades. Even with two expected rate cuts from the Fed in 2024, the differential remains substantial.

For the yen to strengthen significantly, we believe it would require a combination of a Bank of Japan (BoJ) rate hike, an elevated level of quantitative tightening (QT), and perhaps the Government Pension Investment Fund (GPIF) starting to repatriate funds to Japan. Until such factors come into play, dislodging carry trades in USD/JPY will be as challenging as getting a cat to bathe.

So, keep an eye on Powell today and the CPI on Thursday—they might just add the much-needed spice to the currently bland FX market stew.

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