EUR/USD And GBP/USD Continued Weakness

We have held a long-term bullish view on the USD since the Federal Reserve’s June 24 FOMC statement. Our view has been tested in the early days of July, but we remain convinced that EUR/USD and GBP/USD will fall.

Our reasoning stemmed from the FOMC statement and the actions of the US 10-year Bond Market. To re-iterate our statements of two weeks ago we believe that the FOMC’s statements would cause bond investors to drive yields significantly lower, thereby causing the USD to strengthen. Our thesis is based on the actions of the 10 year bond and the USD in the aftermath of the Fed’s previous FOMC statement.

In the previous FOMC statement (April 29) we saw the Fed encouraging traders to think that the Fed was looking to raise rates in the US by the end of 2009. The result was a weakening of USD vs EUR and GBP as traders in the bond market sold their bond positions and repatriated their funds, driving up EUR/USD and GBP/USD. We saw the yield on the 10 year bond hit the 4.00% mark for the first time in recent memory.

This FOMC statement led traders in bonds to believe that the Fed would not raise rates anytime soon. We expected that those same traders that were selling bonds and USD last time would come right back and buy USD and then bonds.

We were correct in that the US 10 year bond market has moved significantly higher in price (which moves opposite yield) as yields have hit 3.25% today. This is an astonishing move compared to the historical volatility of the US 10 year bond. BUT we have not seen a correlated strengthening of the USD! There is a breakdown of the relationship between US 10 year bond prices and the strength/weakness of the USD.

Yet we remain committed to our strong USD scenario. Though the bonds have had the majority of their move already, we expect that the USD will catch up soon enough. We may not see the length or strength of movement in GBP/USD and EUR/USD that we saw from the end of April through the end of June, but we will see continued pressure on EUR/USd and GBP/USD to move lower.

The charts below are of both EUR/USD and GBP/USD with highlighted time periods of the last two FOMC statements. We have see the movements of the bond market based on FOMC statements…..this time we are waiting on the USD to catch up.

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