Yield Dynamics Put EUR/USD Weakness into Perspective


The ECB on Thursday last week disappointed euro bulls as they went into a four-day weekend. They hoped for something more than an almost unchanged assessment, especially after inflation in March again surprised to the upside. Between the lines we still read that a July rate lift-off is certainly possible, but the euro required a clearer signal. EUR/USD fell from an intraday high of 1.0923 to below 1.08 but managed to close above still (1.0828). That was just postponing the inevitable though. The pair in the days thereafter, admittedly in low-volume trading, eased further.

As of this morning, EUR/USD is trading in the 1.077 area; a support zone marked by the February-May 2020 correction lows. In case of a break we’re eyeing a return to the pandemic low of 1.0636. This looks increasingly likely, especially with Fed governors now starting to talk about 75 bps rate hikes. The governor in case, Bullard, said it was not his base case today but remember how 50 bps moves was no-one’s either, until recently.

Moves in EUR/GBP were similar yet less dramatic from a technical point of view. The duo forfeited 0.83 but steered clear from the 2022 low. It even staged a minor rebound after hitting support at the lower bound from the downward sloping trend channel into the high 0.82 zone currently.

Interest rate markets behaved interestingly. The European front-end eased a few bps in the wake of the ECB leaving markets still a bit in the dark with respect to the timing of a first hike. The German 2y yield neared 0% but a return into negative territory was never really an option (0.05%). Europe’s 2y swap finished at 0.70%, down 3 bps. The long end, however, underperformed heavily. The steepening (8 bps rise in the German 10y yield or 9-10 bps in swaps) came as inflation expectations remain on the rise. Markets judge the ECB as being too slow to react. Depending in the gauge, indicators melt up to cycle/multi-year highs or even series highs.

Reports (from the NYT) that the EU is moving towards adopting a phased-in ban on Russian oil obviously add to such moves. In just five days, Brent jumped from $100 to $113/b currently.

Yield dynamics also put EUR/USD weakness into perspective since inflation expectations in the US have plateaued. Real yields are the driving force there. The 2-y yield stabilized near but below 2.50%. The 10y yield however just yesterday hit a new cycle high of 2.85% and the 30y is within 6 bps of the 3% landmark.

It is also what is crushing the Japanese yen: USD/JPY soars past 128 this morning to a 20-year high. We see few reasons for the current yield trends to dramatically reverse course for the time being. As such, there’s no stopping king dollar either.

News Headlines

In the Minutes of the April policy meeting, the Reserve Bank of Australia indicated that time is coming closer for conditions to be fulfilled to raise its policy rate. The RBA sees core inflation rising above the 2%-3% inflation target band in the Q1 and further upward pressure is likely. The RBA also sees wage growth picking up, however this still develops at a pace that is likely below rates that are consistent with inflation being sustainably at target. The Bank will closely monitor important additional evidence on both inflation and the evolution of labor costs. Markets are discounting a rate hike first rate hike for the June 7 policy meeting. The Australian 2-y yield rose 7.8 bps to 2.11% this morning. The Aussie dollar rebounded slightly after recent correction to trade near 0.7370. Economic data for the first quarter published in China yesterday painted a mixed picture. GDP growth unexpectedly rose from 4.0% Y/Y to 4.8% Y/Y YTD. Industrial production eased to 6.5% YTD Y/Y, retail sales growth slowed from 6.7% YTD Y/Y to 3.3%. The March figure even declined to -3.5% Y/Y. The surveyed jobless rate also unexpectedly jumped from 5.5% to 5.8%. The property sector faces ongoing headwinds (residential property sales YTD declining to -25.6%). In a statement, the PBOC announced a series of 23 selective measures to support the economy. Amongst others, the package includes relending programs making funds available for banks to continue to finance sectors that are hit by lockdowns/the consequences of the pandemic. The Bank also advocates banks to continue to support financing to local governments’ projects and other major investment projects. For now, the bank didn’t signal any RRR cut or broader rate reduction.

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