In last week’s post on the USD we noted the importance of bond yields in terms of triggering a rally in the USD – Yields have moved higher as expected and this has helped to firm the USD but can it continue to firm? The market is heavily bearish the USD and speculators hold their biggest short position since 2011 which could mean more strength as the bearish extreme peaks and traders exit dollar shorts on stop.
Bond market yields are on the rise and the higher yield reflects the cost of debt and the future direction of interest rates which is up. For example, the Yield on US bonds is far better than the yield on European bonds with the US 10 Year being positive and the German 10 Year a negative yield at – 0.50.
The 10 Year V DXY US Dollar Index
If we look at the chart below we can see the US 10 Year in June July traded in a perfect downtrend channel in June and July before breaking higher. The DXY did the same trading in a similar channel and has now broken out to the upside. When the 10 Year broke out the majority didn’t believe that the 10 Year would continue higher (which it did) most don’t see the USD trading higher now.
Why Bond Yields Are Firming
Last week Joe Biden and the Democrats announced a huge stimulus package of $1.9 trillion which the majority in the market saw as potentially bearish the USD but as we argued in a previous post the stimulus is actually bullish the USD. Bond traders are pushing the yield on US debt up due to the fact there will be more spending which means bigger deficits, more [Treasury] supply which will push interest rates higher.
Another factor that could come into play is a jump in inflation – the market again doesn’t see inflation rising quickly but the big fiscal stimulus in the US is inflationary and a key indicator is already on the rise: ISM Prices Paid which is a good leading indicator of CPI is moving strongly up and if this continues it’s another bullish fundamental for bonds:
Market Heavily Short the USD
In terms of the USD the market is heavily short as per the chart below – in 2011 when the position was as extreme as it is now the USD mounted a major rally and we could see a sizeable rally again as the USD corrects its oversold extreme.
EUR/USD Analysis
In terms of the EUR, we have seen a break below the 1.2200 level as expected and looking for more weakness. Euro zone has negative rates and negative bond yields which will pressure it lower v the USD in our view and furthermore, the lockdowns are more severe in Europe than the US which means the US economy will outperform Euro zone’s going forward. Chart and key technical levels to watch below:
EUR/USD DAILY CHART: The EUR broke the 1.2200 level and we have now moved away from the level and see bounces to first level resistance as selling opportunities and expect longer term a move down to 1.1800 then 1.1600.
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