By :David Scutt, Market Analyst
- EUR/USD moves have been increasingly negatively correlated with US longer-dated bond yields over the past month
- Readthrough suggests EUR/USD is akin to a barometer for US hard economic landing risks
- US data calendar is dominated by labour market indicators this week
- Nonfarm payrolls on Friday may settle the debate on how much the Fed cuts rates later this month
Outlook overview
Longer-dated rate differentials between the US and Europe look to be influencing movements in EUR/USD again, with correlations over the past month strengthening to levels rarely seen in recent years. With Fed chair Jerome Powell making it clear the Fed is highly likely to begin cutting interest rates later this month, it suggests incoming US labour market data, and the interpretation from FOMC members, may dictate direction in the week ahead.
With markets continuing to price over 100 basis points worth of cuts from the Fed in 2024, and most labour market indicators holding up ok, it suggests directional risks for EUR/USD may be skewed towards the downside.
Yield differentials influencing EUR/USD moves
EUR/USD is not a FX pair known for being driven by interest rate differentials, but the chart below showing the rolling 20-day correlation with a variety of US and European interest rate markets suggests it is right now, especially for longer-dated instruments.
I’ve labeled each market, but there’s only three I really want to focus on: Yield spreads between the US and Germany for five and 10-year tenors, along with US 10-year yields. I’ve used German spreads as a proxy for Europe given it’s the largest economy in the euro area.
Relative to shorter-dated yields and yield differentials, the inverse correlation EUR/USD has seen with longer-dated securities has strengthened noticeably over the past month. And when you look at the inverse correlation with US 10-year yields, at -0.85, it suggests it’s more the US side of the equation that is influencing the pair, rather than Europe where the equivalent correlation with German 10-year yields sits at an insignificant 0.07.
Click the website link below to get our exclusive Guide to EUR/USD trading in H2 2024.
https://www.cityindex.com/en-au/market-outlooks-2024/h2-eur-usd-outlook/
EUR/USD a barometer of US hard economic landing risks?
While it’s not just the Fed interest rate outlook that influences yield movements further out the bond curve, as a market measure of expected growth, inflation and economic uncertainty in the future, recent movements likely reflect shifting market expectations on whether the Fed will be able to deliver a soft economic landing. It was notable that in early August when Fed rate cut pricing started to balloon, EUR/USD strengthened despite the risk-off environment.
Given Jerome Powell made it crystal clear during his Jackson Hole speech that incoming US labour market data will determine when and by how much the Fed cuts rates in the coming months, and given many economists believe a hard or soft landing is determined by the evolution in unemployment, it suggests EUR/USD traders need to pay extremely close attention to any new information on the US jobs market in the week ahead.
As this calendar from Refinitiv reveals, there’ll be no shortage of data for traders to digest this week.
Event risk ramps up this week
Source: Refinitiv
While in isolation the JOLTS survey, ADP National Employment report, Challenger layoffs, jobless claims and ISM manufacturing and non-manufacturing reports carry the potential to generate short-term market volatility, the most influential data point will be the August non-farm payrolls report on Friday.
Even though revisions to prior data raises serious questions about the veracity of the payrolls number, markets are still likely to initially react to this figure. However, given the Fed’s focus in on the unemployment rate, that is arguably the more important number when it comes to the magnitude of rate cuts the Fed will deliver over the coming months.
I’d also throw in the U6 underemployment rate as something to look at given it measures not only unemployed workers but also workers who can and would like to work more hours but can’t due to economic reasons. If activity is not strong enough to provide enough work for those already employed, it is not a great sign for those looking to obtain work.
New York Fed President John Williams is scheduled to talk 15 minutes after the payrolls report is released, with Fed Governor Christoper Waller also speaking soon after that. Keep a close eye on any remarks they make referencing the payrolls report.
EUR/USD reversing bullish breakout
Looking at EUR/USD on the daily timeframe, you can see how the bullish breakout that occurred earlier in August has faltered over the past week as US longer-dated Treasury yields pushed higher. RSI (14) has entered a downtrend while MACD has crossed over from above, confirming the bearish signal on momentum.
From a technical perspective, the EUR/USD reversal stalled on Friday at 1.10493, a level that has acted as both support and resistance since December last year. Given the proximity of the price to the level, traders could use it to build setups around. Shorts are favoured in the near-term given price momentum and momentum in the US economic data.
One setup would be to sell a clean downside break of 1.10493 with a stop above the level for protection. Potential targets include 1.0948 and former downtrend resistance currently found around 1.0925. If EUR/USD were to hold above 1.10493, the setup could also be reversed, with longs initiated above the level with a stop below for protection. 1.1100 and 1.1200 are potential targets.
– Written by David Scutt
Follow David on Twitter @scutty
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