EURUSD - playing the flow through rate differentials
Arguably the focus last week was the incredible moves in the EU bond market, as the ECB opened the door to rate hikes in 2022 – the market has responded pricing 50bp of hikes this year from the ECB, with the deposit rate expected to rise to +61bp in 3 years. EUR was bid vs all currencies on the week, only outdone by the SEK.
On the week, the biggest absolute move (in basis points) fell on the 5-year part of the German bond curve, where yields rose an incredible 34bp – moving away from a negative yield for the first time since May 2018.
While US Treasury yields rose too, we saw the discount German bonds held vs US Treasuries drop from -2.08% to -1.76%. EURUSD followed, rallying to 1.1438 – yet, failing at the 13 Jan swing high. While the world has tactically flipped EUR bullish, the momentum trader in me would now only be a buyer on a daily close above 1.1438.
I expect yield differentials to continue to dictate the flow of capital into EURUSD, but this week it’s really the US CPI that will be the key driver. With the market eyeing 7.3% YoY on headline CPI, we must ask where the balance of risk sits. One way we can think about this is to look at our assessment of movement – assume a miss at 7.1% or a beat at 7.5%, which do you think we promote a bigger move in EURUSD?
For me, the bigger move comes from a beat to US CPI than a miss, although a downside miss would muddy the macro story and have a few questioning if the aggressive rates hikes that are priced is correct and talk of peak inflation may be heard.
We also hear from ECB President Lagarde (Tuesday 02:45 AEDT) and ECB members Guindos, Villeroy, Lane and Elderson.
Near-term we may see some heat coming out of the move, with price testing the 5-day EMA – however as we head into the US CPI print, I expect EURUSD to be driven by real and normal rate differentials – so put the (DE05Y – US05Y) spread on the radar and overlap EURUSD against it – if this spread heads higher (i.e. German yields move more aggressively higher vs the US) then EURUSD should take out 1.1438. If the spread contracts, then EURUSD bulls may get a chance to buy in at 1.1342.
The point is, if you want to know what is driving EURUSD from a fundamental perceptive then its good to see that 2- and 5-year rate differentials are where we should be looking.
@chrisweston_PS
On the week, the biggest absolute move (in basis points) fell on the 5-year part of the German bond curve, where yields rose an incredible 34bp – moving away from a negative yield for the first time since May 2018.
While US Treasury yields rose too, we saw the discount German bonds held vs US Treasuries drop from -2.08% to -1.76%. EURUSD followed, rallying to 1.1438 – yet, failing at the 13 Jan swing high. While the world has tactically flipped EUR bullish, the momentum trader in me would now only be a buyer on a daily close above 1.1438.
I expect yield differentials to continue to dictate the flow of capital into EURUSD, but this week it’s really the US CPI that will be the key driver. With the market eyeing 7.3% YoY on headline CPI, we must ask where the balance of risk sits. One way we can think about this is to look at our assessment of movement – assume a miss at 7.1% or a beat at 7.5%, which do you think we promote a bigger move in EURUSD?
For me, the bigger move comes from a beat to US CPI than a miss, although a downside miss would muddy the macro story and have a few questioning if the aggressive rates hikes that are priced is correct and talk of peak inflation may be heard.
We also hear from ECB President Lagarde (Tuesday 02:45 AEDT) and ECB members Guindos, Villeroy, Lane and Elderson.
Near-term we may see some heat coming out of the move, with price testing the 5-day EMA – however as we head into the US CPI print, I expect EURUSD to be driven by real and normal rate differentials – so put the (DE05Y – US05Y) spread on the radar and overlap EURUSD against it – if this spread heads higher (i.e. German yields move more aggressively higher vs the US) then EURUSD should take out 1.1438. If the spread contracts, then EURUSD bulls may get a chance to buy in at 1.1342.
The point is, if you want to know what is driving EURUSD from a fundamental perceptive then its good to see that 2- and 5-year rate differentials are where we should be looking.
@chrisweston_PS
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