EUR/USD: USD outlook and forecast
Our view is the USD has no big downside and will shortly have a major rally to the upside and the reason is bond yields are rising – bond traders see higher inflation ahead and rising interest rates but the majority of Forex traders don’t and still remain bearish of the USD.
As we have noted since the start of the year the USD will shortly have a big rally its shown some strength but there is a lot more upside to come in our view. How important are bond yields? There a key driver of currency pairs – recently we noted the EUR looked a good risk to reward sell based upon the yield gap between the US and the EU which we will look at later in this article but first, in terms of bond yields for anyone unfamiliar with them some background on why they are important below.
As the yield on bonds rises they become more attractive to investors to invest in and the US has the world’s largest and most liquid bond market and overseas investors who buy bonds have to, of course, buy the USD. At present, the most important indicator to watch in terms of USD strength is the bond market.
The recent fiscal stimulus package in the US will be inflationary and there are numerous indicators pointing to inflationary pressure on the rise. While the Fed say they will not be raising interest rates soon the bond market is already pointing to higher borrowing costs.
The trend channel since Aug lows can be seen clearly on the chart below. The horizontal line is 1.15% and the top of the channel is at 1.25% and if we were to break out of the channel we think we should quickly rise to 1.500. the bond is rising of course with inflation expectations which are also plotted on the chart below.
It’s not just the 10 year on the way up its bonds generally – The US yield curve continues to steepen, with the 5Y-30Y spread trading at its steepest level in more than 5 years.
In terms of the charts below -inflation expectations are at a record high which points to higher yields and rising inflation can be seen clearly in a number of economic indicators such as US PPI and the US ISM indexes.
EUR/USD The Gap In Yields Driving the EUR Lower
Bond yields are on the rise in the US and the gap is widening between US and Euro zone bonds which is pressuring the Euro lower – Euro zone has negative interest rates and negative bond yields which points to lower prices.
We have covered EUR/USD from a technical perspective in a post this week and see the EUR going down to 1.1600 with any rallies being selling opportunities. We have bond yields clearly in favor of the USD and a large speculative position long the EUR and short the USD. As JP Morgan note the USD short position remains ~2 standard deviations below the 5-year average if euro long position exits the market (which we think it will) the EUR will continue to sell off to the downside.
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