How The Euro Needs Bund Yields And The Dax To Go Higher

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Includes: EWG, FXE, HEWG, UUP, VGK
by: Chris B Murphy

Summary

The euro has been given a boost recently from soaring 10-year German Bund yields.

With the European Central Bank leaving rates unchanged and the Fed likely to hike rates this year, the euro will need to look for outside help to drive it higher.

European political events or a Fed hike could drive the euro lower for longer towards 1.03, but a dovish Fed could boost the euro upwards towards 1.0850.

The European Central Bank (ECB) met last week and as expected, left monetary policy unchanged. However, the euro rose despite rumblings of a Fed hike.

Typically, the euro would weaken with the divergent monetary policies between the U.S. and Eurozone. Higher interest rates or expectation of higher rates typically strengthens a currency since the country attracts more investment capital.

Capital flows in and out of the Eurozone would likely affect those investing in the PowerShares DB USD Bull ETF (NYSEARCA:UUP), and CurrencyShares Euro Trust ETF (NYSEARCA:FXE). Also European markets will be affected especially iShares MSCI Germany ETF (NYSEARCA:EWG), iShares Currency Hedged MSCI Germany ETF (NYSEARCA:HEWG), and the Vanguard FTSE Europe ETF (NYSEARCA:VGK).

Here's a possible explanation for the recent run-up in the euro. We'll look at a few key euro rate levels from the charts as well as the momentum indicators for the euro going into the Fed meeting this week, and beyond.

German Bund yields on the rise:

  • At the top of the chart, the recent rise in yields from late February has correlated to the euro bump higher. Also, the December rise in yields also corresponded to a euro rise during that period. It's important to point out that the euro does not always correlate positively to bund yields.

However, if the recent rise in euro has been driven by Bund yields, then any pullback in yields would likely send the euro lower.

  • A break higher beyond .487% with a few days closing above it, (red line on the chart) would likely drive bund yields higher and further boost the euro in the coming days and weeks.
  • Watch out for any sell-off in the German Dax. A break lower of the pink trendline connecting the lows from early February, and a close below 11,830 and 11,750 would be bearish for German equities. As a result, the euro may fall in sympathy, especially if the equity selloff is due to political uncertainty in the eurozone.

Euro weekly chart:

  • The euro is still in bearish territory. As we can see from the chart, in December the euro broke the March 2015 low of 1.05 to the downside (red circle) and closed out for that week at 1.0448.
  • We need to be cautious of any euro strength since the euro may simply be retracing the bounce higher off the bottom set in December.
  • For euro to rise: A break of the orange trendline connecting the lower highs of the move down and a break and a weekly close above 1.0850 would be short-term bullish for the euro. Medium-term resistance would likely come in at around the 1.09 level.

  • For the euro to fall, a break and a weekly close below 1.0490 would likely push the euro lower towards 1.0340.

RSI and momentum:

Review: How to read RSI (Relative Strength Index):

The Relative Strength Index (RSI) is a momentum indicator and an overbought-oversold indicator.

Typically, in a bull-run, we want to see RSI above 50 for a strong move higher. If it breaks below 50, we typically get a pullback. However, if RSI breaks below 40, we tend to see a more significant correction.

Please bear in mind, RSI (or any indicator) is not a predictor of price action; it merely represents the momentum in the market. Fundamentals drive the market, not the charts.

  • RSI is not above the 50 level (blue line) yet which is needed for a substantial bullish run.
  • However, we do see higher lows in RSI (pink lines) which may indicate momentum is on the rise.

Of course, neither the charts or indicators drive the euro.

What to watch:

  • The fate of the euro will likely be affected by Fed policy and the number of rate hikes this year. Even if the Fed comes in and only hikes two times this year (versus the three hikes expected), the euro might get a short-term boost. But over the medium to long-term, the divergent monetary policies between the U.S. and the ECB would ultimately win out, and traders would likely sell into rallies capping any euro gains, and eventually sending it lower.
  • Political outcomes in Europe and the resulting response by the ECB will also be key drivers for the euro.
  • Watch the 10-year German bund yield to get a sense of whether the Eurozone will see an increase or decrease in capital flows. Higher yields should lead to more capital inflows; boosting the euro, and the opposite is true for lower yields.

More articles to follow to keep you updated on the global markets, equities, financials, the Fed, and yields in the coming days and weeks.

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