Euro trades with a bearish tone across the FX dashboard lately. The common currency declined against the U.S. dollar or the Japanese yen, and the move looks set to continue.
The European Central Bank (ECB) has become increasingly worried about the euro’s strength, despite the fact that the euro real effective exchange rate, when based on the PPI (Purchasing Parity Index), reveals that the euro’s strength should not be a concern. However, long yields are a concern for the central bank, and for this reason, the market players expect that the ECB will step up their daily purchases under the PEPP program this week. Whenever this happens, if other central banks do not follow similar actions, the buying should weigh on the euro some more.
EURUSD Back to 1.20
The unwanted rise in bond yields is not something the ECB wants. Bond yields rise when investor’s optimism increases, as is the case now that the worst of the pandemic appears to be behind us.
The benchmark exchange rate against all traders compared to the strength of the common currency is the EURUSD exchange rate. It recently fell over two hundred pips in three days, on the back of a strong dollar but also a weak euro.
While the ECB is worried about the increase in the yields, we cannot say the same thing for the Fed. Actually, the Fed’s Chairman, Jerome Powell, used the congressional testimony last week to reassure markets without hinting that the Fed will increase the asset purchases. Remember that the price of a bond and its yield have an inverse relationship. Therefore, when the yields are rising, the price of the bonds are declining, and the other way around. Now that the yields are rising, if the Fed steps up the buying of bonds, it will automatically trigger a decline in yields.
For the ECB is different. The central bank became vocal lately, especially last week, when it expressed its willingness to do some more. Hence, more bond-buying in Europe should weigh on the yields – and also on the common currency.
For traders, it means that the euro should be under pressure in the days/weeks ahead, should the ECB’s buying will not be matched by similar actions from other central banks.