DB FX Daily: London EUR and rate spreads

[RTFX-Trading]

FX Daily: London
EUR and rate spreads
Today's Key Data and Events
CHF KOF Swiss leading indicator for July, 2.01 expected (09:30 GMT)
USD Q2 adv GDP, 3.2% saar expected (12:30 GMT)
USD UofM consumer confidence for July (final), 91.2 expected (14:00 GMT)

Upcoming Event Risks
Aug 3 US non-farm payrolls
Aug 7 FOMC rate decision
Aug. 8: RBA rate decision
Aug. 15: Norges Bank rate decision

Move lower in EUR/JPY has seen a correction back to nominal rate spreads
The move lower in EUR/JPY over the past week has been quite sharp - with the pair down at the time of writing around 2.5% over the week. This move lower has now brought EUR/JPY back into line with the Eurozone/Japan 2 year swap spread (as shown in the chart) and has returned the 20 day trailing correlation between the two to a little over 80%. The re alignment of the 2 year rate spread with EUR/JPY suggests to us that a continuation of the medium term trend higher in this cross will likely need to be accompanied by an ongoing widening in the Eurozone/Japanese interest rate differential in order for it to be sustained.

And EUR/USD also back in line with rate spreads
We have argued in past editions of our FX daily that the move in EUR/USD (indeed in a range of USD crosses) looked a little extended against rate differentials. As our second chart below shows (snapshot taken late Thursday afternoon in London) the differential between the 4th Eurodollar and Euribor contracts and EUR/USD is now back in line.

In our view the re-establishment of the levels relationship between rate spreads and these EUR crosses re-affirms the current importance that interest rate expectations are playing in fundamentally underpinning the EUR. It also suggests that while further extensions of the broader longer-term trend higher in EUR/USD and EUR/JPY are possible (and in the case of EUR/USD we would think likely), in order to be sustained relative economic and interest rate expectations will need to keep up with (or lead) moves in FX markets.

Adam Boyton
Strategist
(+1) 212 250-8646
[email]adam.boyton@db.com[/email]