Euro-to-Dollar Rate Vulnerable to Move Back to 1.16 says Analyst Eyeing Bond Market Developments

Image © European Central Bank

The Euro is under pressure against the Dollar with market commentators and analysts all pointing a finger at a rise in U.S. bond yields as being the major culprit.

The yield paid on U.S. bonds continues to rise, with an acceleration being seen in recent days, on fears that U.S. inflation is about to turn notably higher.

In response, the Euro-to-Dollar exchange rate (EUR/USD) fell by 0.56% on Wednesday in a decline that extends 2021's losing streak and prompts questions as to whether the psychologically significant 1.20 level is next.

The exchange rate is at 1.2066 at the time of writing with bank transfer rates being offered in the 1.1648-1.1730 region and FX transfer specialists offering rates in the 1.1980 region.

U.S. bond investors fear that their investments will be eaten away by higher inflation in the future, and are therefore demanding higher coupon payments on these bonds as compensation.

The rising yield on these bonds is in turn said to be attracting the interest of foreign investors who are entering the market and bidding up the Dollar as a result.

Above: The rise in U.S. Treasury yields in 2021 is providing support to the Dollar.

Secure a retail exchange rate that is between 3-5% stronger than offered by leading banks, learn more.

Should the current trends continue, the Dollar could push the EUR/USD exchange rate lower over coming weeks.

"For now, even real U.S. yields have risen on this latest blitz of treasury selling, and a continuation of the spike at anything even approaching the recent velocity could support the greenback and push EURUSD over the edge of 1.2000 and thus into the old range down toward 1.1600," says John Hardy, Head of FX Strategy at Saxo Bank.

Expectations for higher inflation in 2021 and 2022 have picked as investors anticipate a strong economic rebound over coming months, courtesy of a vaccination programme that will allow shuttered parts of the economy to reopen.

But it is a looming fiscal injection being planned by the U.S. administration that sets the U.S. economy apart from that of the Eurozone, where nothing nearly as generous is on offer. The stimulus on offer in the Eurozone differs across its various members, with different policies spread over different timezones.

At the EU level, the European Commission's NextGenerationEU stimulus plan is stalled, meaning the €750BN temporary recovery instrument won't have an impact on the region's economic fortunes for some time.

{wbamp-hide start} {wbamp-hide end}{wbamp-show start}{wbamp-show end}

The U.S. is moving fast however as President Biden wants a $1.9TRN stimulus plan to be executed in coming weeks, which could trigger U.S. economic outperformance and higher inflation rates that all point to a stronger Dollar.

"We further believe that the improving U.S. outlook, on the back of aggressive fiscal stimulus and better control over the Covid pandemic, coupled with more persistent inflation overshoot could result in higher UST yields and a somewhat stronger USD in coming months," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole.

A number of commentators we following say that much of the single currency's underperformance has to do with the region's slow vaccine rollout that has seen 5.0% of the population receive a first dose of a covid-19 vaccine.

This sets up an unfavourable contrast with the rapid vaccine rollout in the U.S. which means over 12% of the country's population has now received one dose of the vaccine as opposed to 5.0% in the EU.

Foreign exchange analysts at JP Morgan have said the EU’s slow vaccine roll-out appears to have contributed to the recent pullback in the Euro. "Missteps in the EU’s roll-out have doubtless contributed to the recent pullback in EUR/USD," says Paul Meggyesi, a foreign exchange analyst at JP Morgan.

Meggyesi says the Euro was looking overvalued relative to fundamentals at the start of the year and that a comedown was likely given that some of the factors that drove the single currency's strength in 2020 have now been effectively neutralised.

"Price action over the past few weeks has been a little more sympathetic to our view that the air was getting thin for EUR/USD and that consolidation with a modest negative bias was a more probable scenario," says Meggyesi.