After the euro fell to a 16-month low against the dollar during the latter part of yesterday’s trading session due to a steepening in the US yield curve, the pair continued to tumble this morning as renewed Covid restrictions in European countries and headlines around the Nord Stream 2 pipeline threaten growth conditions in the bloc.
The largest move in the currency pair occurred yesterday when the spread between 2-year and 10-year US Treasury yields widened by nearly 5bps as longer-term yields broke above 1.6% for the first time since the November Fed meeting following Wednesday’s record US CPI release. The euro and Japanese yen are most sensitive to rising back-end yields given their domestic monetary policy remains ultra-loose. The rise in the US 10-year meant both currencies saw significant losses yesterday and this morning despite the USD strength being more moderate across the G10.
Looking at this morning’s move, which drove EURUSD to a fresh 16-month low, it was largely driven by news around Germany suspending the certification process for Russia’s Nord Stream 2 gas pipeline.
The headlines led to a jump in gas prices this morning, which further weighed on the euro as concerns around growth conditions and higher inflation in the region intensified and compounded growth concerns that have arisen from tightening lockdown measures over the past week. The German energy regulator said it could not proceed with the pipeline because the entity behind the pipeline is registered in Switzerland, not Germany. European spot prices for gas, which were already elevated following the supply crunch across the bloc and increased demand over the last months, jumped upon the news.
Dutch (navy) and German (turquoise) 1D forward natural gas prices spike after Nord Stream 2 news
Over the short-term, the increased pressure on US yields, European energy prices and domestic Covid conditions is likely to place further downside pressure on our 1.15 EURUSD call for year-end and may see EURUSD fall towards lows of 1.1160 last seen in June 2020, but for such a move we think markets would need to see a more materially hawkish shift from the Fed.
Looking ahead to the coming months, there is the potential for the Federal Reserve to taper more aggressively than what is currently relayed by them, although the December meeting should give markets more clarity on this.
At the December meeting, the Fed will need to announce their taper plans for January ahead of their meeting on the 27th, while the dot plot should give greater forward guidance on the overall pace of tapering in order for rates to rise in line with the new consensus projection. If the December meeting confirms the aggressive market expectations and sees the Fed front-running the taper process, not only do we expect the single currency to fall towards June 2020 levels but for downward pressure on EURUSD to extend into the beginning of 2022, especially if Covid conditions keep economic activity pinned in the eurozone.
EURUSD breaks through another 16-month low as different narratives weigh on the pair
Author: Ima Sammanil, FX Market Analyst