Euro Remains Fragile For Now
- Feb 20
- 3 min read
GBP : European bond market sell off unwelcome
UK Chancellor Rachel Reeves may have even more difficulties if the European bond markets keep plunging. She must persuasively explain how the government will adhere to its fiscal guideline of a balanced budget by FY29/30, as her expenditure update is due on March 26. She may not be able to postpone spending cuts until later in life, as rising gilt yields raise the bar for a realistic spending plan. Reeves may have to either: a) make more significant spending cuts or b) run the risk of a negative market reaction if her proposals are not credible if gilt yields are testing their January highs by March. Most people are still skeptical that the GBP/USD exchange rate can maintain gains over the $1.2600 mark in the foreseeable future because neither scenario looks good for Sterling.
EUR : Euro remains fragile
A new theme arising from geopolitical situations is the Euro's continued weakness. According to US isolationism, Europe needs to significantly boost its defense budget, but who will pay for it? Lack of consensus could force the cost onto national budgets; Italy is especially vulnerable because of its debt-to-GDP ratio, which is close to 140%. When markets realize that national governments would be responsible for the costs, the recent tightening of the Italian-German bond spread could reverse, according to ING's rates team. Yesterday, markets started to respond, with bond curves steepening and European debt underperforming. At 38 basis points, the German 2-10 year Bund curve is at its highest level since October 2022. An increase in the supply of government bonds might cause peripheral spreads to expand and give the Euro a new fiscal risk premium.
In the meantime, there is no trade risk premium in EUR/USD, and as there are no indications of US consumer weakness or an impending rate drop by the Fed, it is anticipated that the pair will stall above $1.0450/70, with a potential decline to $1.0350 if pressure is applied to Italian bonds.
Although no significant surprises are anticipated, February consumer confidence is included in today's Eurozone data agenda at 15:00 GMT. Concerns about trade and security should maintain high savings rates and restrained demand even in the face of low unemployment and growing real incomes.
USD : Dollar still supported after FOMC minutes
The DXY Dollar index is a little weaker, primarily due to events in Japan. The absence of government opposition to rising JGB yields and the possibility of a rate hike by the Bank of Japan this summer appear to have reassured local investors. A 25bp boost in July is currently priced in by the markets at 21bp, raising the policy rate to 0.75%. Despite slight rate movements, the Yen has strengthened more than anticipated, and speculative posture is currently fairly long. Even though most people don't think the USD/JPY will fall much below ¥150.00, tomorrow's Japan CPI report might cause more short-term losses. Most people, however, prefer the Yen's superior performance on the crosses, especially when compared to the Euro.
Most people believe that the dollar will continue to be maintained. The January FOMC minutes were not very dovish, which strengthened the Fed's position that more progress is required before rate decreases, even if short-dated US rates fell 2 basis points. Philip Jefferson, the vice chair of the Federal Reserve, also emphasized how wealth effects contribute to robust household balance sheets. FX markets are also processing President Trump's remarks from the previous day regarding a possible new trade agreement between the US and China, which momentarily affected the USD/CNH exchange rate in Asia. This by itself, though, is not likely to cause a significant change in the value of other currencies. It is anticipated that DXY would maintain support slightly below 107 unless there is an unexpected increase in US jobless claims today.
