When EUR/USD last traded 1.0465 April 2015, the German yield curve was negative up to the 9 year yield and appeared to be trading below the deposit rate. German yields 1- 8 years viewed from a negative perspective is actually minus 0.119 but annualized then yields still remain far above the deposit rate at 0.88. The same interpretation can be seen in the European interest rate curve as minus 0.0515 transformed is actually 0.94 and again far above the deposit rate.
What’s striking is the German yield curve from 1- 10 annualized at 0.77 trades below the deposit curve and correlates 0.20 Vs the corresponding US 1- 10 year yield curve at 1.28, a difference of 0.51 from the six corresponding points. What explains the low Correlation and deviation is German Vs US swap rates at the 1 year yield remains positive 0.355 on the German side and negative 0.355 on the US side. German minus US and US minus German reveal a swap range between + 0.77 and Minus 0.77. If German yields are viewed in its entirety from 1 -10 then yields sit dead on the deposit rate. A break takes price to 0.75 as the range holds at 0.84. A break further determines if EUR/USD achieves the current yield forecast bottoms at 1.0512 and 1.0459. The 10 – 30 portion of the curve determines the EUR fate.
The 1- 30 German yield curve from 0.8748 again trades above the deposit rate and correlates vs the 1.65 US yield curve at 0.65, a difference of 0.77. The 10 – 30 drives both the German and USD yields as the correlation is 95%. The German mean at 0.96 vs USD at 2.55 reveal a spread of 1.59. The 1- 30 German range is 1.60 and 1.56 from swap rates between 1- 10 year.
Not only is EUR/USD at an important inflection point but the German curve is also at a critical juncture. If Yellen remains on hold, Draghi and the ECB may very well lower the Deposit rate. If Yellen raises then the work for Draghi will be done as the US spreads will widen Vs the Germans and should see a far drop for the EUR.
Brian Twomey, Inside the Currency Market, btwomey.com