FX The dollar is King for a day

The dollar is back in vogue today as the EUR sells off. It seems like good news is bad news for the single currency, which is falling even though the Eurozone composite PMI for June jumped to its highest level for three years and the latest news out of Greece sounds promising. The reason why the EUR is ignoring domestic developments is because the FX market appears to be focused on the dollar and the next steps for the Federal Reserve, and not the Eurozone.

What is up with the EUR?

Interestingly, the EUR is falling alongside EURUSD short term volatility. This means that as the options market gets more positive on the EUR (volatility falling), the spot market is turning bearish in the short term, and EURUSD is down some 120 pips so far on Tuesday. (See figure 1).

As we lead up to US durable goods orders this afternoon the US dollar index is erasing recent losses and attempting to test some key resistance – the 50-day sma at 95.60 – if we get above this level it would be a short term bullish development that could open the way to 96.15 – the 100-day sma. Whether or not we can get past these short-term hurdles could depend on the outcome of today’s durables goods data. Even though this can be a volatile index, a strong number could boost the buck and help it to further re-trace last week’s Fed-related sell-off.

How to reignite the dollar rally:

One way to reignite the dollar rally would be a large increase in US short term Treasury yields. Although the USD has a myriad of drivers, yields matter. Interestingly, over the last few weeks the dollar has had a significantly stronger relationship with 2-year yields than with the 10-year yield, which is considered the Treasury benchmark. Thus, the near term outlook for the dollar could be dependent on short term yields (see figure 2).

2-year yields have been clawing back recent losses, and are now at 0.66%, approx. 7 basis points below the pre-FOMC meeting high. If 2-year yields can break above the prior high at 0.72% then it could be seen as a green light for dollar bulls. Strong US economic data this week, including durable goods data for May and an upward revision to tomorrow’s Q1 GDP release, may be enough to boost yields and thus the buck for the next few days.

Takeaway:

• The EUR is ignoring domestic factors today.
• Even though the EURUSD options market is more optimistic on the single currency, the spot market is weakening.
• The dollar is the king in the G10 FX space today.
• Whether or not the dollar rally is reignited once and for all could be dependent on the advance of short term dollar yields, which are an important driver of the dollar right now.

Figure 1:

Source: FOREX.com. Please note that this chart does not represent prices offered by FOREX.com