Euro Rally Continues Driven by Sovereign Bond Yields

Weekly Forex Market Analysis

Last week we saw quite unusual movements in the currency market. While the dollar's rally continued against most non-European currencies, supported by strong economic data and expectations of the imminent rate increase by the Federal Reserve; The euro and the pound managed to outperform the dollar and therefore almost all major currencies.

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The strength of the euro is due to the strong sale of European bonds that we are witnessing, to a higher interest rate, which should be a support for the currency, since it is a reason to attract investment flows. In the case of the pound, the flurry of positive macroeconomic news confirms our theory that growth is likely to rebound above 3% in the second quarter, which could bring forward expectations for UK rate hikes, helping boost the pound above both the euro and the dollar.

 

EUR

 

Last week it was confirmed that first quarter growth in the euro zone closed at a modest 1,5%. However, the most important development related to the common currency has been the continued rise in the yield of Eurozone sovereign bonds, whose interest rate has risen by around 1% from April lows. In the short term this factor is providing good support for the euro, since higher yields attract greater financial flows from investors around the world in the short term. However, in the medium term the increase in yields does not directly help the recovery of the euro zone. German Chancellor Merkel decided to express her displeasure about the strength of the euro publicly, although her statements only had a temporary impact on the currency market and the common currency rallied again to finish the week comfortably above the dollar.

 

Negotiations with Greece continue, as does the effort to reach an agreement. The market has taken a fairly relaxed attitude on the possibility of Greece leaving the Eurozone and has preferred to focus on the increase in bond interest rates.

 

GBP

 

Possibly the most important news in the United Kingdom last week was those referring to the housing market. Inquiries from potential buyers increased sharply and house prices are expected to increase. The signs of another possible speculative wave in the United Kingdom, and especially in London, are not good news for the Bank of England. We continue to expect the first rate hike to occur in the first quarter of 2016. As markets increasingly agree with this view, rate hike expectations are exerting strong support for sterling.

 

USD

 

Last week we again received signs that the US economy is recovering from the first quarter slowdown. Retail sales were higher than expected. The headline figure rose 1,2% month-on-month, driven by auto sales and rising gasoline prices, reflecting the strength of consumer spending. Underlying retail sales have increased an annualized 7% over the past three months, consistent with the notable acceleration in domestic demand. All eyes are focused on this week's FOMC meeting, to find out the Fed's reaction to the undeniable acceleration of economic growth in the US, as well as the possible schedule for rate hikes by the Fed.

 

Enrique Diaz-Alvarez

Ebury Risk Director