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If you look at EUR/USD this week, it may be easy to think that the euro is holding up and brushing aside the warning signals from the bond market. But in taking a step back, you might find that perhaps EUR/USD is not giving markets the full picture of the risks surrounding the euro at the moment.
The currency pair is holding up decently this week, trading around 1.1240 levels today after bouncing off support near 1.1200 on Monday. However, I wouldn’t want to mistake that resilience for a sign that traders are becoming more comfortable with Europe’s underlying problems.
I mean, the fact of the matter is that the bond market is telling us quite the opposite. The France-Germany 10-year yield spread has now widened to around 161 basis points, its highest since 2011.
As a reminder, this spread essentially tells us how much extra compensation that investors are demanding to lend money to France rather than Germany. And with France already struggling with fiscal uncertainty, political instability, and rising borrowing costs, that premium is becoming more and more difficult to ignore.
And yet, we’re not seeing the same kind of urgency in EUR/USD this week. Puzzling, eh?
Looking at the daily chart, the pair is still in a tough spot in keeping below the key daily moving averages and managing just a light bounce after hitting a low of 1.1113 last week. But now, the recovery attempt is seeing the pair test resistance around 1.1250-60 with the 23.6 Fib retracement level at 1.1254 in focus. But still, there’s little reason to suggest that the broader technical picture has improved significantly unless buyers can break through that and look to test 1.1340-50 levels next.
Having said that, it is not to say that sellers are firmly in control to pressure the pair lower in chasing a further downside break below 1.1200 currently. So, what gives?
Well, perhaps the more telling chart right now is EUR/CHF.
The pair has already broken below its trendline support from the March to May lows, alongside the 100-day moving average (red line) near 0.9300 earlier this month. And now, sellers are putting pressure on the 200-day moving average (blue line) around 0.9235. A sustained break below that could open the door towards 0.9200 initially, before putting the 0.9000 level back into focus.
Considering that the franc tends to benefit when investors become more defensive about European risks, EUR/CHF might actually be the best indication of how traders are pricing in euro risks at the moment. And from the chart, they are saying that the euro might be on the verge of a steeper decline if things continue.
Circling back to EUR/USD, the fact that dollar sentiment is also another big part of the equation is perhaps why the pair hasn’t been the best gauge of euro risks this week. The dollar has struggled in the past few sessions as Treasury yields are sticking with the sharp pullback from last week. 10-year yields are still at 5.09% today, nearly unchanged from the start of the week itself.
So if you’re looking for signs that traders are growing more uncomfortable with Europe’s fiscal outlook, I would argue that EUR/CHF and the French-German yield spread deserve far more attention than EUR/USD alone right now.
This article was written by Justin Low at investinglive.com.
