Euro-Dollar Seen at 1.19 by RBC Capital Markets

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• EUR/USD spot rate at publication: 1.2107
• Bank transfer rates (indicative guide): 1.1680-1.1767
• FX transfer specialist rates (indicative): 1.2021
• More information on specialist rates, here

Foreign exchange strategists at RBC Capital Markets are targeting a decline in the Euro-to-Dollar exchange rate (EUR/USD) in the short-term, annointing the call their "Trade of the Week".

The expectation for Dollar strength and Euro weakness lies with an observation that the yield paid on U.S. government bonds - in particular 10-year bonds - continue to rise, stimulating demand for the Greenback.

"The rise in US yields has so far had limited positive impact on USD, not least because yields have risen in parallel in other major markets, diluting the impact on spreads. With equities selling off over the last week (and futures weak again this morning)," says Adam Cole, Chief Currency Strategist at RBC Capital Markets.

Above: Four hour chart showing EUR/USD movements in 2021

The yield paid on ten-year U.S. government debt reached a one-year high at 1.394% on Monday as investors started to fret about rising inflation rates in the future.

When expectations for higher inflation in the future rise, investors demand a greater return be paid on the bonds they purchase in order to be compensated for higher future inflation.

Hence, at the heart of the current 'stronger dollar' dynamics is an expectation for higher inflation in coming months.

"Historically, when bond and equity prices move in the same direction, markets have tended to become USD-directional and negative returns in both markets are associated with USD strength," says Cole.

"It would be early to suggest this is a longer-term theme, but short-term, if higher yields cause further indigestion in equities, expect USD to be the FX beneficiary," he adds.

RBC Capital Markets meanwhile expect month-end flows to be negative for the Dollar this month, but they add they have never found any evidence of EUR/USD being affected.

RBC Capital are targeting a decline in EUR/USD to 1.1900.

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Investors expect inflation rates in the U.S. and globally to start rising as the world economy recovers from the covid-19 pandemic, aided by a generous support packages from the U.S. government.

All the while the U.S. Federal Reserve maintains a generous programme of quantitative easing and low interest rates which is unlikely to change before 2022.

"We think progress in vaccinations, market reassessment on the size and composition of the fiscal relief package (as Democrats opt for the budget reconciliation process) and potential for a medium-term infrastructure package drove the move in real yields. Higher yields amid stronger US growth are tailwinds for the dollar," says Ashish Agrawal, an analyst with Barclays.

Inflation expectations in the U.S. have risen steadily from their nadir in March 2020 when the covid-19 pandemic starter to sweep the globe and caused a significant slump in global asset prices.