Idea of the Day: Time to get serious about the euro

What: The euro is the third best performing currency vs. the USD today, as the single currency gets a boost from the surge in German bond yields to a 17-month high.

What: The euro is the third best performing currency vs. the USD today, as the single currency gets a boost from the surge in German bond yields to a 17-month high. Yields are a key driver of currencies, and the rise in German yields to above 0.5% is a significant level of resistance. Now that this has been broken, some banks including HSBC are expecting German 10-year yields to rise to 0.9% by year end.

We believe this will be a key driver of euro strength this year. Other factors include a pick-up in speculative long euro positions, which are close to their highest level since 2013. The economic and political backdrop is also supportive, with the debt crisis mostly confined to the past, the economy picking up speed and the unemployment rate dropping to its lowest level since 2009.

Overall, we think that this stage of the ECB’s policy cycle, where it has just shifted towards a less accommodative stance, is also euro supportive. This shift in the ECB’s stance is reflected in the yield spread between the Germany and the US, as you can see in chart 1 below. The spread is at its highest level since November, and it looks like it could continue to move higher, which is euro supportive.  

How: In figure 2 below you can see that EUR/GBP has been stuck in its tightest range for nearly 3-years. This is significant, with the ECB and BOE roughly at the same stage of their monetary policy cycles – both toying with the idea of taking a more hawkish path – this is limiting the movement in EUR/GBP. Thus, we would not suggest traders taking a position in this pair to capitalise on potential euro strength.

Instead, we believe that EUR/USD offers a better opportunity. From a fundamental perspective, we believe that the strength of German yields will continue to support EUR/USD, as you can see in chart 1. From a technical perspective, 1.1445 – last week’s high - looks like an easy challenge. Above here opens the way to a significant level of resistance at 1.15 – the top of the long term range. In the longer term a key resistance level to break is 1.1741 – the 38.2% retracement of the 2014 high to 2016 low, and then 1.20, which is a key psychological level. If German bond yields can reach 0.9% by year end then a 600 point move higher in EUR/USD looks like it could be a possibility.

Chart 1: 

Source: City Index and Bloomberg

Chart 2: 

Source: City Index 

Build your confidence risk free
Join our live webinars for the latest analysis and trading ideas. Register now

StoneX Financial Ltd (trading as “City Index”) is an execution-only service provider. This material, whether or not it states any opinions, is for general information purposes only and it does not take into account your personal circumstances or objectives. This material has been prepared using the thoughts and opinions of the author and these may change. However, City Index does not plan to provide further updates to any material once published and it is not under any obligation to keep this material up to date. This material is short term in nature and may only relate to facts and circumstances existing at a specific time or day. Nothing in this material is (or should be considered to be) financial, investment, legal, tax or other advice and no reliance should be placed on it.

No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although City Index is not specifically prevented from dealing before providing this material, City Index does not seek to take advantage of the material prior to its dissemination. This material is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.

For further details see our full non-independent research disclaimer and quarterly summary.