EUR/USD is set to fall to fresh year to date lows

USD: More of the same as the USD hits new highs alongside US yields

The US dollar has continued to strengthen during the Asian trading session alongside the ongoing adjustment higher in US yields and the price of oil. It has helped to lift USD/JPY closer to the 150.00-level while EUR/USD has fallen to within touching distance of the year to date low at 1.0484 from 6^th January. For this month as a whole the US dollar has strengthened sharply against the other major currencies of the yen (-2.6% vs. USD), euro (-3.1%), Swiss franc (-4.1%) and pound (-4.2%). The US dollar rally yesterday was reinforced by the jump higher in long-term US yields. The 10-year US Treasury hit an intra-day high of 4.64% which was up sharply from the intra-day low of 4.49%, and extended the adjustment higher from the low at the start of this month to almost 60bps. According to Bloomberg, the Fed’s measure of the term premium on a 10-year zero coupon bond has moved back into positive territory for the first time since November of last year, and is now back above the average level over the last decade. The recent move higher in long-term US yields have been encouraged by the ongoing rally in the price of oil that has helped to lift market-based measures of inflation expectations. However, the impact on the 10-year break-even rate has remained relatively modest so far. It has continued to trade within the 2.20% and 2.40% range that has been in place for most of the past year.

The ongoing adjustment higher in US yield reflects building optimism over a softer landing for the US economy combined with the Fed’s plans to keep rates higher for longer. The resilience of the US economy so far this year to higher rates is encouraging the recent adjustment higher in US yields. The release today of the US GDP report for Q2 is expected to provide confirmation that the US economy continued to expand above the Fed’s estimate of potential growth, with economic releases in recent months pointing towards a similar pace of growth continuing in Q3. However, there is some risk that the pace of growth could be revised lower. As we highlighted previously, there has been an unusually marked divergence this year been GDP and GDI growth which casts some doubt on the resilience of economic expansion. One immediate threat to US economic growth at the start of Q4 is the looming threat of a government shutdown. Bloomberg is reporting today that a last-minute deal to finance the government and avoid a shutdown is unlikely. The report makes the case that House speaker lacks the leverage to force the government into a last minute financing deal to avoid a shutdown. While the developments are unlikely to take the shine off the US dollar in the near-term, we expect evidence to build in the coming quarters that the US economy is unlikely to remain as resilient. It supports our outlook for the US dollar to re-weaken from more overvalued levels in 2024.                 

LONG-TERM YIELDS PRICING IN A HIGHER TERM PREMIUM 

Source: Bloomberg, Macrobond & MUFG Research 

EUR: Weak money supply data adds to concerns about ECB over tightening

The broader US dollar rally is keeping downward pressure on EUR/USD as it moves closer to the year to date low from January at 1.0484. The euro has also lost some ground against the yen in September. After hitting a high of 159.76 at the of August,  EUR/JPY has since fallen back to a low overnight of 156.77. The recent move lower in EUR/JPY is partly a reflection of the stronger pushback from Japanese officials against further yen weakness while euro-zone officials have not expressed concern yet over upside risks to the inflation outlook from a weaker euro. Rhetoric from Japanese officials continues to signal a high risk that intervention could be imminent to support the yen as USD/JPY moves closer to the 150.00-level. Japanese Finance Minster Suzuki warned again overnight that they are watching FX closely with a sense of urgency, and that they won’t rule out any options against excessive FX moves and will take appropriate policy response if excessive FX moves.

At the same time, the euro is being undermined the ongoing loss of confidence in the outlook for the euro-zone economy. Even the release of the better than expected euro-zone PMI surveys and German IFO survey for September have failed to provide more support for the euro in the near-term. Market participants remain concerned that the ECB have overtightened monetary policy which has increased the risk of a euro-zone economy falling into recession and/remaining in a more prolonged period of stagnation. Those fears were reinforced yesterday by the release of the weak money supply report for August that provided more evidence that the impact of past policy tightening is continuing to feed through. The report revealed that bank lending to businesses has slowed almost to standstill in August which was the weakest reading since late 2015.                

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
GE	13:00	German CPI (YoY)	Sep	4.6%	6.1%	!!
US	13:30	GDP (QoQ)	Q2	2.1%	2.0%	!!!
US	13:30	Initial Jobless Claims	--	215K	201K	!!!
US	21:00	Fed Chair Powell Speaks	--	--	--	!!!

Source: Bloomberg