EUR/USD: when the US dollar and yields rise in tandem, trouble often follows

The breakdown of EUR/USD does not bode well for investor risk appetite moving forward, pointing to the growing risk of higher volatility and weaker asset prices moving forward.

An environment of US dollar strength and rising US bond yields never typically goes down well with investors, sucking capital like a sponge back to the United States. The longer it persists, the greater the risk of volatility, often culminating with something “breaking”. Think emerging markets, lower-rated sovereign and corporate bonds, currencies whose central banks are powerless to repel potential attacks. It’s been shown time and again that when the US dollar and yields rise in tandem, trouble follows.

EUR breakdown backed by fundamentals

Right now, US yields are threatening to break to fresh multi-decade highs while the US dollar has risen to levels not seen in months. The momentum is moving in the same direction, raising questions as to what will stop it?

The Fed could turn neutral or even dovish towards the inflation outlook, but that seems unlikely unless US economic data starts to roll over noticeably. Another is for activity to strengthen in other parts of the world, especially in China and the Eurozone. But that looks remote near-term, including in Europe where expectations for further ECB rate hikes are rapidly diminishing, contributing to the EUR/USD breaking down on the charts. You only need to look at the relative levels of recent PMIs to see why the EUR is flailing while USD is sailing.

Representing such a large proportion of the US dollar index (DXY) – nearly 60% -- a continuation of EUR weakness will really get the US dollar wrecking ball going, especially when the Japanese yen is also under significant selling pressure. Given the momentum, fundamentals and potential for renewed turbulence in markets, the risk-reward for EUR/USD looks skewed to the downside.

Risk-reward for EUR/USD looks skewed to the downside

Having broken the 200-day SMA and uptrend that began in March, it’s hard to get excited about the prospects for renewed upside. Those with high conviction for an extended selloff may be willing to enter shorts here, although pushes back towards 1.0800 may offer more attractive levels for those with a shorter trade timeframe. A stop above 1.0800 will help to limit losses should the pair unexpectedly reverse. On the downside, a support zone from 1.0680 established in June is the first port of call. Should that go, a flush down to 1.0500, or even 1.0360 may be on the cards.

-- Written by David Scutt

Follow David on Twitter @scutty

How to trade with City Index

You can trade with City Index by following these four easy steps:

Open an account, or log in if you’re already a customer

• Open an account in the UK
• Open an account in Australia
• Open an account in Singapore
Search for the market you want to trade in our award-winning platform
Choose your position and size, and your stop and limit levels
Place the trade

From time to time, StoneX Financial Pty Ltd (“we”, “our”) website may contain links to other sites and/or resources provided by third parties. These links and/or resources are provided for your information only and we have no control over the contents of those materials, and in no way endorse their content. Any analysis, opinion, commentary or research-based material on our website is for information and educational purposes only and is not, in any circumstances, intended to be an offer, recommendation or solicitation to buy or sell. You should always seek independent advice as to your suitability to speculate in any related markets and your ability to assume the associated risks, if you are at all unsure. No representation or warranty is made, express or implied, that the materials on our website are complete or accurate. We are not under any obligation to update any such material.

As such, we (and/or our associated companies) will not be responsible or liable for any loss or damage incurred by you or any third party arising out of, or in connection with, any use of the information on our website (other than with regards to any duty or liability that we are unable to limit or exclude by law or under the applicable regulatory system) and any such liability is hereby expressly disclaimed.

City Index is a trading name of StoneX Financial Pty Ltd.

The material provided herein is general in nature and does not take into account your objectives, financial situation or needs.

While every care has been taken in preparing this material, we do not provide any representation or warranty (express or implied) with respect to its completeness or accuracy. This is not an invitation or an offer to invest nor is it a recommendation to buy or sell investments.

StoneX recommends you to seek independent financial and legal advice before making any financial investment decision. Trading CFDs and FX on margin carries a higher level of risk, and may not be suitable for all investors. The possibility exists that you could lose more than your initial investment further CFD investors do not own or have any rights to the underlying assets.

It is important you consider our Financial Services Guide and Product Disclosure Statement (PDS) available at www.cityindex.com/en-au/terms-and-policies/, before deciding to acquire or hold our products. As a part of our market risk management, we may take the opposite side of your trade. Our Target Market Determination (TMD) is also available at www.cityindex.com/en-au/terms-and-policies/.

StoneX Financial Pty Ltd, Suite 28.01, 264 George Street, Sydney, NSW 2000 (ACN 141 774 727, AFSL 345646) is the CFD issuer and our products are traded off exchange.