The USD has been leading the way in major currency performance for several weeks. However, as the USD has just tailed off in the past couple of weeks, this has enabled the EUR to grind out a near-term recovery. The drivers of this include a more hawkish ECB and latterly the tightening of core/peripheral yield spreads. A plethora of ECB speakers and key Eurozone data this week will keep EUR in focus for traders.
- Bond yield spreads are supportive of EUR versus GBP and JPY, but less so versus USD.
- This week’s ECB Forum on Central Banking is likely to be a near-term driver of EUR moves.
- Also, the Eurozone inflation data will be key.
Yields are broadly supportive of EUR
We have seen EUR picking up versus all major currencies (aside from the Swiss franc) in the past couple of weeks. We have seen this in the performance of the currencies relative to the USD.
We are continuing to see yield differentials (using German bonds as a Eurozone benchmark) continuing to improve. This is helping to drive a EUR recovery.
This is certainly the case looking at the 10-year yields of German Bunds versus the Japanese Government Bond. The higher Bund yield relative to the JGB is sustaining a rally on EUR/JPY.
We are also seeing this in Bunds versus UK Gilts on the 10-year.
However, the position is less clear for Bunds versus Treasuries. Looking at the 2 year (which gives a strong indication of fx direction) the spread is widening in favour of the US once more. This may begin to restrict the near-term rally on EUR/USD.
The drivers behind the EUR rally
More hawkish rhetoric out of the ECB has been a driver of the EUR rally. Markets are prepared for a 25 basis points rate hike this month by the ECB. However, there is a growing expectation that there could be a further 50bps in September too. This has helped to steady the EUR.
In the wake of a hawkish take on the ECB monetary policy decision on 9th June, the initial for bond markets in the subsequent days was to sell off peripheral bonds (such as Italian BTPs) and more than core bonds (the German Bund). This widened spreads and alarmed EUR traders, causing a sharp move lower in EUR. The EUR/USD pair fell from c. 1.0750 to 1.0400 in just over two days.
However, the ECB has since announced that it would be looking into ways to mitigate these fears and the spreads have tightened once more. This has helped the EUR to recover once more.
However, one thing we will be looking out for this week will be whether this spread begins to widen again. There is an ECB forum on central banking in which several Governing Council speakers will be giving their views on growth, inflation and the monetary policy response. This could turn the focus back on bond markets (core and periphery) within the Eurozone. The moves on spreads could again impact EUR positions.
We will also be watching the economic data this week, with Eurozone inflation topping the bill on Friday. Given what the central banks say at the ECB forum, any significant moves higher in Eurozone inflation will drive the expectation of the bigger 50bps hike in September. This would help the EUR rally versus JPY and likely against GBP. The impact on EUR/USD could be determined by the action on Eurozone core/periphery yield spreads. If the spread widens to any significant degree, this is likely to weigh on EUR/USD (and we may see pressure on 1.0350).
Technical outlook on EUR
We have seen the EUR rallying over the past couple of weeks. On EUR/USD we see this move is up towards a test of the mid-range pivot resistance around 1.0600/1.0640. However, with a three and-a-half-month downtrend adding to resistance c. 1.0650 we still prefer to use rallies as a chance to sell. Reaction to the 1.0470 higher low will be an important gauge near term.
The gains continue to be posted on EUR/GBP and on Monday the market is moving higher once more and will be eyeing a test of 0.8640 resistance (last week’s high). There is still a strong technical position in play, with the RSI consistently holding above 50 (suggesting weakness is a chance to buy) and supported by a 10-week uptrend and the rising 21-day moving average. As things stand, a move towards a retest of the 0.8720 high is building. We watch the support at 0.8510 as a breach would suggest the rally has come to an end.
On EUR/JPY there has been an uptrend in place all but since the beginning of March. The 55-day moving average has been a basis of support in this, but latterly the rising 21-day ma (c. 141.10) has taken on this role. Weakness continues to be seen as a chance to buy and the market is positioning once more to test the 144.25 resistance which has been hit twice in June. This is the only barrier between here and moves towards 149.00 which was the multi-year peak in December 2014.
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