G10 FX Weekly – Come-back of the euro

by: Georgette Boele

  • Euro’s comeback because of higher German bond yields …
  • Strong US employment report saved the US dollar
  • Australian dollar rally quickly ran out of steam

Euro’s come-back…

This week, the euro had an impressive come-back. The significant rally in German government bond yields greatly outpaced the rally in US Treasury yields. This provided strong support to the euro across the board. At the start of the week, higher than expected eurozone inflation numbers triggered a rise in German bond yields and Mario Draghi missed the opportunity to calm investor sentiment. The euro is very sensitive to developments in interest rates and bond yields. So the narrowing of the spread between Germany and the US has been clearly supportive for the euro (see graph below). As a result, EUR/USD moved above 1.1300. On Thursday and Friday this spread widened again because of some pressure on German Bund yields and higher US Treasury yields after the stronger-than-expected US employment report. Going forward, we expect EUR/USD to move lower because of ECB’s QE and the start of Fed rate hikes, which will support the dollar.

 

… strong US employment report saved the US dollar

For most part of the week the US dollar was the weakest performing major currency. Mixed US data during the week was not of great support. The most significant weakness was versus the euro because Treasury yields did not manage to keep up with the rise in German bund yields. But on Thursday a turnaround was seen because the rally in German Bund yields ran out of steam and US employment report beat expectations. The higher than expected non-farm-payrolls numbers and hourly earnings brought the possibility of a Fed rate hike back into focus again. This has given strong support to the US dollar. If next week, retail sales also perform well, the US dollar could make significant strides across the board. USD/JPY has already moved above 125.50 and its uptrend seems unstoppable for now.

Australian dollar rally ran out of steam quickly

The Reserve Bank of Australia kept monetary policy unchanged at 2.0% as widely expected. In addition, it maintained the neutral tone in the forward guidance. This neutral guidance disappointed part of the market that had expected a signal of more monetary policy easing. As a result, the Australian dollar rallied. The better than expected GDP report has resulted in a further pricing out of a possible rate cut. However, the details of this report were not that strong and we remain of the view that the central bank will cut rates by 25bp in Q3. Later during the week, retail sales disappointed and this weighed on the Australian dollar. We remain negative on the Australian dollar with our year-end target of 0.72 in AUD/USD.