Despite rising Greek default risk that sent European indexes like the DAX plunging, the EURUSD is showing strength. Here’s why, to play it, and the longer term potential dangers for the EUR and Euro-zon.
Yesterday the EURUSD made its 5th straight test of the strong resistance at the 100 day EMA around 1.118. Although it failed to close above it, today it has broken above yet again, and is holding on as the Asian session winds down. The driver of this persistent strength is significant, so we’ll follow up yesterday’s EURUSD analysis with this one.
Fundamental Drivers: EURUSD Benefiting From Greek Anxiety Effects On EU Bonds, US Trade Deficit
This EURUSD strength seems odd at first glance given the rising anxiety about Greece, which drove both Greek and most other EU stock indexes sharply lower yesterday, with the STOXX 50 down 1.24% and both the DAX and Madrid indexes down over 2.5%.
Ironically, (and counter-intuitively) it’s this very fear that’s supporting the EURUSD, because it’s driving EU bond prices higher and yields lower to reflect the rising risk. For example Tuesday’s bond markets showed that while 10 year US Treasury note yields were up 2bp, European bond yields rose even more. Italian and Spanish yields of the same maturity jumped 27bp, French yields 9bp, and German bund yields 6bp.
The pair typically follows the spread between US and EU bond yields, and is clearly doing so now, particularly because yesterday’s economic events did not offer any explanation for EUR strength.
EU Bond Weakness: A Short Term Strength, A Longer Term Weakness For the EUR, EURUSD
Although this EU bond weakness is a short term positive for the EURUSD, it could become a negative force, and a big one, if it persists. Here’s why. Long term EU bond price weakness would mean that the ECB’s bond buying program (aka: QE-EU) isn’t big enough to drive EU bond prices down, and thus needs to be expanded. That means expanding the supply of Euros even more, and further undermining the EUR over the long term.
