EUR/USD continues its upward move on August 21 and is climbing toward three-month highs around 1.1700-1.1710. The euro is supported by a noticeable shift in interest rate expectations, with the probability of a near-term Fed rate hike falling sharply after weak U.S. data, while the market is now almost fully pricing in further ECB tightening.
Additional pressure on the dollar comes from the U.S. Treasury market, where the 10-year yield remains around 4.69% and the 30-year yield near 5.25%, despite measures by the U.S. Treasury to stabilize the long end of the curve.
Eurozone retains arguments for a tighter ECB policy
The eurozone macroeconomic backdrop currently appears resilient enough for the ECB to maintain a hawkish stance. The combination of above-target inflation and steady economic activity strengthens the case for raising the deposit rate to 2.50%. The market-implied probability of such a move in September is currently estimated at around 90-95%.
Weak U.S. data limits the dollar's upside potential
The situation in the United States is the opposite. The Fed left its policy rate unchanged at 3.50-3.75% in July, with three FOMC members voting for a 25-basis-point increase. However, after a series of weak data releases, the probability of a September rate hike has fallen to around 30%. The market is increasingly leaning toward the Fed keeping rates unchanged at least at its next meeting.
Treasury buybacks support the long end of the bond market
Another important factor is the U.S. Treasury. On August 19, the Treasury announced that from September 9 through November 4 it would increase the maximum size of liquidity-support buybacks for nominal securities in the 10-20 year and 20-30 year maturity buckets from $2 billion to at least $4 billion per operation. This is an expansion of the Treasury buyback program, not a currency intervention and not QE by the Federal Reserve.
The decision initially pushed the 10-year Treasury yield down toward 4.65% and weakened the dollar, but the effect was quickly partially reversed as fundamental concerns over the budget deficit, government debt supply, and inflation remained in place. For EUR/USD, as I noted in EUR/USD gains face a test as Treasury yields rebound, this creates a moderately positive medium-term outlook. As a result, bulls may continue trying to break through the current resistance, and if successful, they could test the 1.1740-1.1760 resistance area.
Pullbacks toward 1.1680-1.1670 are likely to continue attracting buying interest, but a break below this support would open the way for a decline toward 1.1640-1.1620.
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