When geopolitical tensions over the armed conflict in Ukraine go through the roof and increase the demand for safe-haven currencies, and inflation around the world remains elevated, forcing central banks to tighten monetary policy, one cannot count on the weakening of the US dollar. In the end, those currencies whose issuers raise rates faster win, and the Fed is one of them. The ECB, on the contrary, is in no hurry with monetary restrictions. And this circumstance testifies to the stability of the EURUSD downward trend.
As history shows, 10-year US Treasury yields peak when the Fed hikes rates to its cycle high. Currently, the Central Bank intends to bring borrowing costs to a neutral level as early as 2022 and, most likely, will continue monetary restriction in 2023, albeit at a slower pace. In May and June, it makes sense to count on two large steps of 50 basis points, at all subsequent FOMC meetings – on a rate increase of 25 basis points. As a result, US bond yields could rise to 3.5% in the first half of next year.
Dynamics of the federal funds rate and US bond yields
The ECB is clearly lagging behind. Although the rhetoric of the members of the Governing Council is becoming more and more belligerent. In particular, Vice President Luis de Guindos says that rates could be raised in the third quarter after the termination of quantitative easing programs. The heads of central banks from Latvia and Belgium argue that inflation is at levels that require action, and that an increase in the deposit rate above zero looks like a simple matter. Money markets believe that borrowing costs will rise by 75 basis points by the end of the year, but personally, their growth by 25 basis points seems to me the most likely event in September and December.
In such conditions, when due to the divergence in the monetary policy of the ECB and the Fed, the yield of German bonds is at about 1%, and their American counterpart is at about 3%, the pressure on EURUSD will continue. This circumstance increases the probability of continuation of the downward movement of the pair in the direction of 1.065 and 1.05. Another thing is that in the second half of this year the situation may seriously change.
Dynamics of EURUSD and the yield differential of US and German bonds
First, due to the depletion of fiscal stimulus and aggressive monetary restrictions, the US economy will begin to seriously slow down. It may not come to a recession, as the yield curve predicted, but the recession will be close. On the contrary, against the backdrop of a slow tightening of the ECB's monetary policy and, I would like to believe, an end to the armed conflict in Ukraine, the eurozone will begin to regain its lost ground. As a result, the euro may rise to 1.1 by the end of 2022.
Technically, the rebounding of the pin bar on the EURUSD daily chart indicates the weakness of the bulls. Their opponents intend to update the April low and continue their peak towards the pivot points at 1.071 and 1.066. In such conditions, one should stick to the previous tactics of selling the euro against the US dollar with the above targets.
EURUSD, Daily chart
