Reminder! EURO Alert

Rising inflation remains an important determinant of market’s reaction this year, as rising yields continued to challenge lofty equity market valuations, especially in the technology sector, a topic which we have elaborated upon in the past.

Of critical immediate importance though is as we stated last week are the European markets and their variation of US market. So far today, European yields actually eased lower a bit over the month, thanks to ECB assurances and fresh pandemic restrictions that dampened recovery optimism.  However, in US we have seen  rising mid- to longer-dated Treasury yields, with the 10-year note yield rising over 5 bp from yesterday in testing the 1.770% level for the first time since January 2020.

That said, the US dollar which is concomitant with a vault higher Treasury yields, has continued to ascend, and posted a near 5-month high by the measure of the narrow trade-weighted USDIndex. At the same time, yield differentials have widened more in the US dollar’s favour, with the 10-year T-note over Bund spread, for instance, stretching out to new 14-month highs over 203 bp. A marked yield differential widening has also been seen in the case of the T-note versus JGB yield, while the cases for US versus UK and Australian 10-year yields have seen much less, if any, widening. This yield dynamic has been playing out against a backdrop of overall positive risk appetite. 

Hence this was foreseen since last week, as we stated that the end of month and end of quarter flows could recommence fully the reflation trade, which is what actually happening right now. The bond yields are sharply higher on a combination of the reflation trade and climbing expectations on the recovery thanks to ongoing good news on vaccines, the potential for another $4 tln US stimulus package, some $3 tln in taxes, and supply, not to mention the ultra-accommodative posture of core central banks and the Fed’s benign neglect over rising rates.

Hence we have seen a bullish US dollar, with all major currencies under pressure. However attention is mainly on EURUSD, which as foreseen, the break of 1.1800 strengthened the bearish pressure drifting the asset below this key level to 1.1728 lows, what is now the 7th down day out of the last 9 trading days, as along with fundamentals which for now are not in the favour of the Eurozone, there might had been large stops below 1.1800 causing further depreciation to the asset. This is also the fifth out of the last six week’s of descent, and the third consecutive month that the EURUSD has headed lower. On the year so far, the US dollar is registering as the second strongest of the main currencies.

The data released today such as Eurozone ESI business confidence index which rose above pre-pandemic levels and German state inflation higher than expected, had little bearing on the EURO. Even though this supports the bullish outlook on growth and rising price pressures the yields differentials and the global rollout of Covid vaccines remain the main factors weighing on EURO and boosting US Dollar.

The US economy is widely seen outpacing the Eurozone and other peers this year, thanks in large part to the massive fiscal stimulus along with the more advanced vaccination rollout in the US, which is facilitating societal reopening. Eurozone interest rates are near the most negative in the world (Swiss rates being the exception), and there is little prospect for the ECB to tighten policy on the horizon, contrasting to the debate surrounding the Fed, and the possibility it may be forced to tighten sooner than expected given the regime change in US economic policy.

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Andria Pichidi

Market Analyst

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