FXStreet (Barcelona) – FX Strategists at TD Securities comment on the shift in FX correlation with spreads and further share the outlook for EUR/USD.
Key Quotes
“Sharp moves in DM bonds over the past week have highlighted liquidity concerns in a market that is generally considered to be one of the more (or most) liquid of all asset classes. The rise in core EZ bond yields, which has seen 10y bund yields gain from 0.07% at the end of April to 0.87% now, has reflected a pick up in EZ inflation, some improvements in EZ real data and somewhat brighter assessments of the outlook from the ECB last week.”
“If EZ inflation has troughed, price growth remains weak and there is little prospect of any deviation from full implementation of the ECB’s QE plan at this point. Still, higher yields have crushed EUR-USD spreads—10y differentials have dropped from 190bps three months ago to 150 bps now, undermining the USD and helping lift the EUR.”
“There are two notable developments in correlated daily returns of spreads and spot with think is worth highlighting. Firstly, the correlation between spot EURUSD and 10y spreads (rolling 1-month window) is very tight at +69.9% currently; since 2000, the spot/spread correlation has typically peaked in the +70-75% region. Secondly, 10y spreads have a tighter correlation with spot than the rest of the curve (down to 3m spreads) currently. This is unusual as the 2-5y sector has typically had a stronger correlation with spot in recent months in particular.“
“The high volatility/low liquidity mix for bonds might continue for a little longer but odds favour perhaps some relaxation in the spot/10y correlation.”
“Better US data (retail sales later this week) and heightened attention on the June 17 FOMC in the wake of the strong NFP data suggest that the USD should do better going forward.”
“We look for EURUSD gains to stall in the low/mid 1.13s and drop back to the low 1.12s from here and for spot to perhaps pay less attention to what 10y yield differentials are doing.”
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