EUR/USD tests yearly lows as yield gap favors the dollar

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EUR/USD remains under strong pressure

Eurozone data send mixed signals

Fundamental factors in the eurozone look contradictory. Business activity accelerated in September, with the composite PMI rising to 53.1 from 52.0 a month earlier. Germany is showing clearer signs of recovery: the Ifo index increased from 88.8 to 89.9, beating expectations, while September PMI data pointed to the strongest pace of expansion in almost a year.

However, the latest European Commission data were weaker: the eurozone economic sentiment index fell to 97.9 from 98.4, while consumer confidence declined to -16.5. Inflation remains an additional problem for the ECB: the August figure stood at 3.2% y/y, core inflation is holding around 2.4%, while households’ one-year inflation expectations rose to 3.0%. This limits the room for softer policy, but at the same time high energy prices are becoming an increasingly visible drag on real growth.

France adds another layer of pressure

The divergence between Germany and France is also becoming more important for the euro. German surveys are gradually improving, while domestic demand in France remains weak: consumer confidence in September held at just 86 points compared with a long-term average of 100, the overall business climate indicator stands around 96, and the economy barely grew in the second quarter.

Additional pressure is coming from the bond market, where investors are demanding a higher premium for French debt amid fiscal and political risks. The yield on 10-year Bunds stands around 3.61% on September 29, while European rates in general remain elevated due to the energy shock and inflation risks. This situation does not give the euro the kind of advantage from high interest rates that might normally be expected.

U.S. yields keep the dollar in control

The dollar’s main advantage currently remains on the side of the U.S. Treasury market. The yield on 10-year U.S. Treasuries is holding around 5.23–5.25%, not far from the 5.27% peak, the highest level since 2007, while the 30-year yield is around 5.54–5.56%. Rising oil prices and persistent inflation risks have prompted the market to once again price in further tightening by the Fed.

At the same time, the latest U.S. data still do not provide a convincing reason to expect a sharp cooling of the economy, while on September 30 the market will receive both the third estimate of U.S. GDP for the second quarter and the August PCE report, followed by the employment report on October 2. For EUR/USD, this makes the area of the yearly low particularly vulnerable: European data are gradually improving, but so far this is not enough to offset the higher yields on dollar assets and growing demand for the dollar amid energy and geopolitical uncertainty.

Nevertheless, the move to this year’s lows, as noted in EUR/USD tests major support as U.S. yields keep dollar pressure elevated, may give bears a reason to take profits on short positions, which could lead to some correction in the pair, although a substantial rise is unlikely. We are likely to see either consolidation within a relatively narrow range or persistent attempts by bears to break support and set new lows. The 1.1370–1.1390 area is the nearest potential resistance zone.

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