Weekly: FX – Yield expectations and the economy dominate

by: Georgette Boele

One of the themes we have been stressing is that the euro is a very interest rate sensitive currency. Better-than-expected eurozone data last week pushed German yields higher and this gave support to the EUR. The exception to the rule was against the dollar, with EUR/USD moving lower in the first part of the week. US data also have come in better and they pushed US yields up. The USD received support from higher yields up to the moment that the market started to become nervous about the Fed tapering. When the VIX started to move higher last Thursday and US equity market fell, the USD gave back its recent gains and EUR/USD moved back above 1.3350. We believe that strong US growth will in the end calm down markets and improve investor sentiment. The combination of stronger-than-expected US data, higher US yields and positive sentiment is likely to prove to be a powerful force pushing the USD higher versus the EUR. In addition, we expect the ECB to further dampen monetary policy expectations and short-term eurozone interest rates. We keep our forecast in EUR/USD at 1.20 in EUR/USD for the end of this year.