The EUR has made some significant gains in the past week. The move has come amidst a hawkish surprise from the European Central Bank. ECB President Lagarde did not rule out the prospect of higher interest rates in 2022. The market reaction has been driven through bond yields and EUR is feeling the benefit. As this re-evaluation of when the ECB will embark upon tighter monetary policy takes hold, we believe the EUR could be on a strong run. We look to use weakness as a chance to buy.
- Key bond yields in the Eurozone are rising sharply
- Better yield differentials help to support EUR
- We are watching key levels to EUR crosses
Key Eurozone bond yields are picking up sharply
Suddenly markets have been compelled to price for potential ECB hikes in 2022. According to Bloomberg, even one of the most hawkish members of the ECB Governing Council, Klass Knot (The Netherlands) is not calling for a rate hike before Q4. However, because President Lagarde did not rule one out this year, a re-pricing has taken hold.
Since the ECB meeting, bond yields across the Eurozone have shot higher. Jumps of between 20 to 40 basis points have been seen on 2-year yields (which reflect the immediate outlook for interest rates) and on the longer, 10-year yields too.
We see that the differentials of longer dated yields are driving EUR trades right now. Below we see the chart of 10-year yields for major economies. The German yield has pulled sharply higher relative to other yields of the US, UK, and Japan. The Bund yield has jumped from zero to over +0.20% in the past week.
Yield differentials help the EUR
Looking at yield differentials for German Bunds versus major currency counterparts, we see a likely strengthening of the EUR.
For Bunds versus US Treasury yields, a tightening of the spread to less than c. 165 basis points would be a key moment. This would help to pull EUR towards 1.15/1.16.
The EUR reaction versus GBP could have some scope for considerable momentum. German yields are re-rating at the same time that markets seem to be questioning whether the Bank of England is making a significant policy mistake. This could easily drive the differential to tighten towards 1.05%/1.10%. This would be positive for EUR/GBP towards 0.8550/0.8600.
Finally, for EUR/JPY, the reaction of the yield differential has been huge and this should be a key boost for EUR/JPY in a move higher. A move towards 133/134 should not be ruled out.
Technicals show key levels to be tested
EUR/USD looks primed for an upside break above 1.1480. The level was tested on the ECB decision but has backed away since the strong Nonfarm Payrolls report. We are looking to use this weakness as a chance to buy. We would be looking for a higher low around 1.1360/1.1385 as a chance to buy. A move above 1.1480 opens 1.1525 initially but a move towards 1.1665 cannot be ruled out in a recovery scenario.
EUR/GBP has broken out through a resistance band between 0.8420/0.8460 in the last two sessions. Holding above 0.8420 builds on this strengthening outlook. The Relative Strength Index (RSI) is into the 60s and is also looking more positive. A move towards the next key resistance band 0.8540/0.8600 cannot be ruled out now.
Finally, on EUR/JPY, beaking above 131.50 opened 133.50/134.00 as the next key resistance band. Momentum is stretched near term but we look for unwinding moves to be used as a chance to buy. We are looking for a higher low in the support band around 130.50/131.00.