Overrated Rates
The unwinding of USD implied short term interest rates shouldn’t be underestimated. Take a brief look at changes in FX swap pricing over the past few months and you’ll see just how significant those interest rate expectations have proved to be. Particularly within GBPUSD, the difference is enormous. Post-pandemic inflationary pressures affected the US and UK economies to a similar degree leaving the proximity of the two nation’s interest rates very close indeed. As has been commonplace for the past decade, the US terminal rate stood slightly proud of the UK’s.
Today the FX forward and swap market now reflects a premium paid to lenders of GBP vs USD across all tenors through to the end of the curve. That marks the first time since mid-2023 that the majority of the short end of the GBPUSD forward curve has been negative. Despite the significance of relative rates in GBPUSD there is an emerging case that EURUSD spot rates are over selling the importance of the shift in yields in the US. Given that interest rates have been almost exclusively the justification for the collapse in USD spot valuations, it is hard to argue that a laggard Eurozone economy should be the beneficiary. Sure, gains in EURUSD have been more modest than elsewhere but the pair still sits perched upon a two-year high.
Even at present levels EURUSD seems to be unfairly discounting the growth potential in the USA vs. Eurozone. Especially in light of Germany’s inflation data published yesterday, the case for buying the Euro outright against the Dollar is dim at best. Should the prospect for a soft landing in the USA remain intact whilst Eurozone growth expectations are downgraded, the case for a significant retracement in EURUSD will be all the more compelling. From a technical perspective, upside in EURUSD does look limited despite momentum indicators remaining favourable.
Discussion and Analysis by Charles Porter
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