The British Pound And Euro Surge Despite Higher U.S. Rates

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 |  Includes: DRR, ERO, EUFX, EUO, FXB, FXE, GBB, ULE, URR, UUP
by: Dr. Duru

On Friday, the U.S. 10-year Treasury bond yield hit 3.0%, matching a high for the year. Rate are rising again across the yield curve.

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U.S. Treasury yields are on the rise and back to highs of the year

Source: St. Louis Federal Reserve

This steady march in rates should support a stronger U.S. dollar index (NYSEARCA:UUP). Yet, as the chart below shows, the U.S. dollar continues to hover just above its lows for the year. (Over the last three weeks, the U.S. dollar has managed to bounce off its QE3 reference price - the dollar's level when the Federal Reserve announced QE3 last year).

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The "QE3″ reference price holds as support yet again

Source for charts: FreeStockCharts.com

The British pound (NYSEARCA:FXB) is one of the currencies in the index holding its own and then some against the U.S. dollar. I have spent many posts discussing my bullishness on the pound in reference to improving economic conditions. Bond yields in the UK have accordingly marched higher. The 10-year UK gilt closed out the week at 3.07%, maintaining its small edge against U.S. yields. The market's recognition of improving economic conditions has kept the rally going for the pound. As shown in the charts below, the UK's strong third quarter GDP report provided a catalyst for a major breakout that has held for the past month. The yield differential is helping to confirm the breakout.

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The British pound just barely holds onto its breakout

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The British pound maintains its longer-term breakout

The euro (NYSEARCA:FXE) is the majority component of the U.S. dollar index. The economy and yield stories do not work so well for me when trying to digest the euro's contribution to the dollar's inability to lift-off toward the top of its multi-year trading range. The 10-year for Germany closed the week at 1.95%, France at 2.57%. The very high yields in the rest of the eurozone have a lot to do with shaky credit-worthiness. I continue to think the euro is rising just as a general anti-dollar bet. That trade seemed to reach a pinnacle on Friday when the euro inexplicably surged against all major currencies. This move is seen most clearly in Friday's action for the euro against the U.S. dollar.

The first chart below shows the topsy-turvy EUR/USD action with the ECB (European Central Bank) rate cut initiating a recent bottom in the currency and Fed tapering producing just a momentary pause in the continued grind higher. The intra-day chart shows the extreme, sudden, and sharp nature of the run-up into the highs on Friday.

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The euro surges and completely fades…

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…it all happened in the blink of an eye….

I continue to think short euro will be a strong trade to start 2014. The eurozone has a very unpleasant combination of rising unemployment AND high interest rates (in the periphery). A strong (over-valued?) currency is like an extra two turns on the bolts tying the economy down. I suspect that the ECB will strive in 2014 to devise clever ways to tease the currency lower to support its own fleeting recovery. These charts on stubbornly high unemployment rates for the general and young population are a reminder of the tough task yet ahead for financial authorities in the eurozone.

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The trend for unemployment in the eurozone remains UP

Source: St Louis Federal Reserve (updated through September, 2013)

Be careful out there!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: In forex, I am net short euro, net long pound, net long U.S. dollar.