EUR/USD gains face a test as Treasury yields rebound

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EUR/USD gains face a test as Treasury yields rebound

Rising yields restore some support for dollar

For the dollar, this dynamic creates a more complicated picture than immediately after the Treasury’s announcement. Yesterday, the decline in yields sharply reduced the attractiveness of dollar-denominated assets, DXY fell to three-month lows, while EUR/USD rose above 1.1600 and today tested the 1.1680-1.1710 area. Now, the recovery in yields potentially restores rate support for the dollar and may limit further upside in the pair.

At the same time, the dollar has so far failed to show a recovery comparable with the move in Treasuries, which points to continuing investor doubts regarding the U.S. debt market. The very fact that the Treasury had to intervene after the 30-year yield surged to its highest levels since 2007 has increased attention to the budget deficit, the enormous borrowing needs of the U.S. and the rising premium for holding long-term debt.

JPMorgan also warns that the increase in buybacks may only temporarily suppress yields and could ultimately even increase pressure on the long end of the curve if the market sees the authorities’ actions as an attempt to deal with the consequences rather than with the cause of rising borrowing costs.

EUR/USD now hinges on key yield and price levels

That is why the near-term dynamics of EUR/USD now depend to a large extent not on yesterday’s Treasury decision itself, but on how quickly the Treasuries market fully neutralizes its effect. If the 10-year yield firmly consolidates above 4.70% and the 30-year yield again approaches 5.30%, the interest-rate differential could trigger profit-taking in the euro and push EUR/USD back below its recent highs.

If, however, the new wave of bond selling starts to be viewed as a sign of a deeper crisis of confidence in U.S. fiscal policy, the traditional relationship of “higher yields = stronger dollar” may weaken: higher yields would then primarily reflect an increase in the risk premium, which would potentially remain a negative factor for the USD. This divergence between rising Treasury yields and the dollar’s still weak reaction is currently one of the most important indicators for the FX market.

Thus, an important factor will be the ability of EUR/USD bulls to break resistance around 1.1700, or at least to consolidate above 1.1640-1.1620. Pullbacks toward these levels may attract buying interest, while a loss of the latter level could neutralize the effect of yesterday’s rally and signal a return of the pair to the range in which it traded before yesterday’s advance, as I warned in EUR/USD tests two-month highs as rate expectations shift.

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