Original article by eFXdata
Title: UBS: EUR/USD Needs US Real Yields to Drop Further to Sustain Gains
Rewritten Article (Expanded and Reformatted)
In the latest foreign exchange market insights, UBS delivers a detailed analysis of the EUR/USD currency pair, touching upon the recent upward momentum in the euro and the critical factors that must align for this trend to continue. Below is a comprehensive breakdown of their argument, expanded to include context, broader macroeconomic influences, and potential implications for traders and investors.
Overview of Recent EUR/USD Movement
– EUR/USD has recently made gains, rebounding after a period of downward pressure.
– Investors have responded to signals from the Federal Reserve, particularly suggestions of a possible rate cut later in 2024.
– UBS analysts, however, advise caution, pointing out that the euro’s recent surge relies heavily on declining US real yields. Without a sustained drop in these yields, further EUR/USD appreciation may be unsustainable.
Understanding US Real Yields and Their Forex Impact
– Real yields in the United States refer to returns on US government debt after adjusting for inflation.
– They are determined by the nominal yield on Treasury Inflation-Protected Securities (TIPS) minus expected inflation.
– Real yields play a pivotal role in FX markets as they reflect the real return on USD-denominated assets.
– When US real yields rise:
– Demand for USD-denominated securities increases.
– USD tends to strengthen relative to other currencies, including the euro.
– When real yields fall:
– The relative attractiveness of US assets declines.
– Typically, the USD weakens, allowing for gains in counterpart currencies like the euro.
EUR/USD and the Dependence on Real Yields
UBS notes that recent EUR/USD appreciation can be directly attributed to a decline in US real yields. This has led some investors to embrace bullish positions on the euro. However, analysts from the Swiss bank emphasize that for this uptrend to continue meaningfully, the downward trend in real yields must persist.
Key insights from UBS include:
– The drop in real yields is not guaranteed to be persistent.
– A stabilization or recovery in these yields would likely trigger renewed USD strength.
– Recent EUR/USD strength is thus conditional and appears fragile without corroborating macroeconomic shifts.
Broader Macro Landscape
To understand the dynamics at play, several global macroeconomic themes must be considered:
– Federal Reserve monetary policy:
– Signals of a potential easing have cooled US yields.
– Markets have priced in at least one rate cut by the end of 2024 based on recent data releases and public commentary.
– US inflation trends:
– If inflation proves sticky, the Fed could delay cuts or even consider resuming rate hikes.
– Rising inflation expectations could lead to higher real yields, strengthening the USD and pressuring EUR/USD downward.
– European Central Bank (ECB) policy:
– The ECB has maintained dovish signals but remains data-dependent.
– Unlike the Fed, the ECB is expected to maintain accommodative conditions for longer.
– Policy divergence can also influence EUR/USD direction depending on rate spread expectations.
– European economic performance:
– Growth in the euro area has shown slow and uneven progress.
– Structural weaknesses in the eurozone pose ongoing risks to the EUR outlook.
– Fiscal policies in major economies:
– Large fiscal deficits in the US may keep yields elevated longer-term.
– In contrast, tighter European fiscal policy may maintain pressure on the ECB to provide more support.
Bullish EUR/USD Case Hinges on Long-Term Real Yield Declines
While the short-term view shows a stronger euro, UBS remains cautious about its durability. For a sustainable uptrend in EUR/USD, several things must happen in concert:
– US disinflation must continue, creating space for a real policy pivot by the Federal Reserve.
– Real yields in the US need to decline further, either via lower nominal yields or higher inflation expectations.
– The European macro environment must show signs
Read more on EUR/USD trading.