Euro May Slide to $1.30 on Yield Link Redux
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The euro may weaken to a one-year low of $1.30 as German bond yields dropped to records after the economy shrank at twice the pace analysts forecast, according to IG Markets Securities Ltd.
The CHART OF THE DAY shows the 120-day correlation of the euro and the extra yield five-year U.S. Treasuries offer over German bunds. The correlation reached minus 0.82 yesterday, from 0.65 in May. A reading of minus 1 would indicate the two move in opposite directions, while plus 1 would mean they move in lockstep. The revival of the link between a wider U.S. premium and a lower euro is adding to bearish signs for the currency, driven by Europe’s worsening economy and tensions with Russia.
Data this month have shown euro-area gross domestic product stagnated last quarter as Germany’s shrank 0.2 percent and investor confidence fell to the lowest level since 2012. The standoff between Russia and the European Union over Ukraine is clouding the outlook for nations that share the euro and weighing on efforts by the European Central Bank to jump-start growth and inflation.
“The GDP reports confirm that the fundamentals in Europe aren’t strong enough to absorb some external shocks, such as a flare up in geopolitical risks,” Junichi Ishikawa, an analyst at IG Markets in Tokyo, said today in a phone interview. “The euro may test $1.30 this year on the back of monetary policy divergence between the Federal Reserve and the ECB and prospects for U.S.-German yield spreads widening.”
The Fed is on schedule to end its bond-purchase program this year and futures price an 84 percent chance it will increase its key rate by the end of 2015. ECB President Mario Draghi unveiled an historic stimulus package in June and has said he is willing to do more if the central bank’s inflation outlook changes.
The euro has tumbled 2.4 percent this quarter to trade at $1.3361 as of 12:02 p.m. in Tokyo. The currency will slide to $1.32 by year-end, according to the median forecast in a Bloomberg News survey.
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