EUR/USD pushed its rebound towards 1.1600 as European yields stayed elevated, while US Treasury yields steadied after a recent spike. European curves bear-flattened as equities fell and commodities rose, before US rates calmed in overnight trading. The 10Y UST yield slipped from an intraday peak of 4.75% to 4.69%, and attention is turning to the FOMC Minutes as the next directional catalyst. Separately, final July HICP inflation in the euro area is expected to confirm the flash reading of 2.9% y/y for headline and 2.5% y/y for core.
In Germany, August ZEW expectations rose to 34.2 versus 30.0 expected and 26.3 previously, while the current situation gauge improved to -61.1 compared with -69.3 expected and -77.6 prior. The data comes after a run of firmer euro area growth surprises, with fiscal stimulus adding support. In the US, minutes from the FOMC’s July meeting are due, and the record shows three participants voted for a hike, with others since indicating openness to tightening if incoming data warrants it.
EUR/USD Overextension and Tactical Short Opportunity
We suggest derivative traders prepare for a reversal in the EUR/USD pair as its recent climb toward 1.1600 looks overextended. While European yields remain temporarily elevated, US Treasury yields are already stabilizing, with the 10-year yield slipping back to 4.69% from its recent peak of 4.75%. This divergence creates a tactical shorting opportunity for EUR/USD as the interest rate differential begins to favor the dollar once again.
In our view, the market is pricing in far too many rate hikes from the European Central Bank, meaning European yields have significant room to fall. Historically, when traders overstate the ECB’s hawkishness, a sharp downward correction in euro-denominated yields quickly follows. With final July HICP core inflation expected to hold steady at a moderate 2.5%, there is very little fundamental pressure on European policymakers to keep tightening.
Fragile Euro Strength and FOMC Risks
Although Germany’s latest ZEW economic sentiment index surprised to the upside at 34.2, we believe this optimism is highly fragile and heavily reliant on temporary fiscal stimulus. The current situation index still languishes in deeply negative territory at -61.1, pointing to persistent structural weakness in Europe’s largest economy. This vast gap between future expectations and current reality suggests that recent euro strength is built on shaky foundations.
Looking ahead to the upcoming FOMC minutes, we advise traders to position for potential hawkish surprises from the Federal Reserve. Since multiple policymakers have already flagged their willingness to support further rate hikes if inflation remains sticky, US yields could easily spike again. We recommend utilizing short-dated put options on EUR/USD to capitalize on an expected drop back toward the 1.1300 level in the coming weeks.
