Image 1: Daily Ichimoku Cloud chart for EUR/USD

Image 1: Daily Ichimoku Cloud chart for EUR/USD
Source: Bloomberg

Since this summer, the EUR/USD currency pair has been on a steady path lower, having hit a high close to 1.13 in July, and now lingering just above 1.05. In many ways, it has been the consummate risk-on/risk-off currency pair – rallying for most of 2021, having a difficult 2022 but then rallying again from the fall of 2022 into the highs this summer, similar to other assets in the investing world. What is behind this move?

Image 2: EUR/USD compared to the difference between bund yields and Treasury yields

Image 2: EUR/USD compared to the difference between bund yields and Treasury yields
Source: Bloomberg

I’ll work through potential drivers of the currency pair one by one to see if I can begin to tell the story of what has driven it and what it may mean going forward. The first argument given for currency markets tends to be the interest rate differential argument. While the EU has no good pan-European yield benchmark, I choose to use bund yields, with German bunds being a large source of the supply of government bonds, but also a preferred destination for investors into Europe. If I compare the yield on German bunds to U.S. Treasuries, can I ascertain any pattern compared to EUR/USD?

While it is not a one-to-one comparison, I can see that broader trends in rate differentials appear to have had an impact. From 2013 – 2019, the spread between the two bond markets steadily eroded with EUR/USD trending lower for most of that period. From 2019 – 2021, bund yields widened vs. the U.S., with a big jump around the coronavirus. EUR was a bit higher over that time. From 2021 – 2023, while there has been some volatility in EUR/USD, on net it is still largely at the same level. In the same way, while bunds initially widened vs. Treasuries, now this spread has collapsed and is back to where it was a few years ago. 

While there is a debate about the directional of Treasury yields from here, it would seem that U.S. Treasury bears may also be bears on EUR/USD, as wider spreads (more negative on this chart) would point to lower EUR.

Image 3: ECB balance sheet as a percent of GDP vs. Federal Reserve balance sheet as a percent of GDP overlaid vs. EUR/USD

Image 3: ECB balance sheet as a percent of GDP vs. Federal Reserve balance sheet as a percent of GDP overlaid vs. EUR/USD
Source: Bloomberg

Image 4: SXXP vs. SPX relative index performance compared to EUR/USD

Image 5: EU vs. U.S. consumer confidence vs. EUR/USD

Image 6: EU vs. U.S. Purchasing Manager Index vs. EUR/USD

Image 7: EUR/USD weekly Ichimoku Cloud chart on top and weekly candle chart with moving averages on bottom

Image 8: CVOL Indices for all currency pairs

Image 9: EUR/USD CVOL compared to the underlying

Image 10: EUR/USD skew compared to the underlying

Image 11: Expected return chart for a January EUR/USD 1.04 – 1.06 strangle

Image 12: Matrix that looks at the PNL of the strategy for different moves in futures and volatility

Image 13: Matrix of PNL for strangle position compared to futures movement and time