The global surge in bond yields is being driven by more than just rising oil prices. Markets are increasingly concerned that central banks' reluctance to act decisively could allow inflationary pressures to spiral out of control. Against this backdrop, the Fed may need to adopt a more hawkish stance. Let's examine the situation and develop a trading plan for the EUR/USD pair.
The article covers the following subjects:
Major Takeaways
- Yields on 30-year Treasuries have reached their highest level since 2007.
- Markets are concerned that inflation could spiral out of control.
- The Fed may start considering raising interest rates.
- Short trades on the EUR/USD pair can be opened with targets of 1.144 and 1.138.
Weekly Fundamental Forecast for Dollar
The final roadblock to a stronger US dollar has been cleared. Geopolitical tensions and the resulting rise in oil prices created the perfect backdrop for a rally in the USD index. However, the greenback advanced cautiously amid a surge in US stock indices. Against this backdrop, non-residents typically hedge the risks of equity investments by selling the US currency. The S&P 500's pullback from record highs over three consecutive sessions effectively eliminated the EUR/USD pair's last source of support.
The sell-off in global bonds triggered the pullback in stock indices. Yields on 30-year Treasuries reached their highest levels since 2007. The rally in bond yields is driven not only by fears of accelerating inflation due to the conflict in the Middle East. Japan is leaning toward fiscal stimulus to support the economy and consumers. The UK may follow suit amid a political crisis. The mismatch between tight monetary policy and loose fiscal policy is forcing investors to sell bonds.
30-Year Treasury Bond Yield
Source: Bloomberg.
However, the issue runs much deeper. At the start of the conflict in the Middle East, investors expected central banks to tighten monetary policy aggressively. Then their view changed. Higher interest rates began to be seen as a policy mistake, as they could push economies into recession. The markets were, in fact, eventually heard. The ECB, the BoE, and other regulators initially appeared determined to fight inflation but then began exploring ways to backtrack from their previous rhetoric.
As a result, investors have started to fear a different scenario: that central banks' reluctance to act decisively could allow consumer prices to spiral out of control. Under such conditions, holding bonds becomes far less attractive, forcing markets to demand a higher risk premium. How high could yields rise? According to a Bank of America survey, yields on 30-year bonds could climb to 6% over the next 12 months.
Fed Funds Rate and US Inflation
Source: Wall Street Journal.
In this situation, the only correct solution is for central banks to return to a hawkish rhetoric. The Fed should be the first to do so, calming markets. They will regain hope that the Fed will not allow inflation to run out of control.
In this connection, Kevin Warsh may face significant challenges. Donald Trump, who appointed him as Fed chair, has stated that he would be disappointed if Warsh failed to lower interest rates. However, current market conditions suggest the opposite may be necessary: tighter monetary policy and potentially even higher rates.
Weekly Trading Plan for EUR/USD
The pullback in the S&P 500 index amid surging Treasury yields has removed the final obstacle for the EUR/USD pair on its path toward the targets of 1.144 and 1.138. As a result, short positions can be considered.
This forecast is based on the analysis of fundamental factors, including official statements from financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also considered.
Price chart of EURUSD in real time mode
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