The US Dollar Index resumed the upside in the second half of the week and is now flirting with weekly peaks near 97.20 points. The greenback has a positive impetus from the increased demand for safe-haven currencies against the collapse of the world markets.
News that Chinese telecommunications equipment company Huawei’s CFO was arrested in Canada over a possible breach of US sanctions on Iran inflamed an already tense US-China trade tension and boosted risk-off assets. Analysts note that this can complicate negotiations between the US and China. Buyers returned to the US Treasury market, pushing yields lower, while risk assets fell sharply with global equity markets taking a hefty hit and trading at or near two-year lows. The US Treasury yield curve remains inverted in the shorter-end (3s-5s), indicating that the Federal Reserve may need to loosen monetary policy from 2020.
The yields of the key US 10-year reference have extended the recent breakdown of the critical 3.0% handle and tested 2.88% earlier in the session or fresh 3-month lows.
Why inverted bond yields curve panicked the markets?/h2>
The US bond yields curve inverted, which caused panic in the financial markets. The dollar plunged on Tuesday for worries about the upcoming recession, and Dow Jones Industrial Average wiped out 800 points, turning Tuesday into one of the worst days for markets in 2018.
The interest is the return on the investment someone gets by buying a bond. The curve is the difference between the interest rates of two different bonds that have the same qualitative valuation but a different maturity date.
Interest rates on 10-year US government bonds minus rates on 2-year US government bond yields are often exemplary. Typically, the return on long-term bonds is higher than short-term bonds. In this case, the difference between the two is a positive integer. But sometimes short-term outpaces long-term ones, creating a negative spread. Then the curve turns around.
The reason everyone is excited so much is that the gap between 5-year and 2-year bonds, and between 5-year and 3-year bonds, was negative on Monday. This is the first such case since 2007.
If we take a look at the chart below, we will understand why this has caused such excitement. Every time the difference becomes negative (passes under the blackline of the chart), a recession (colored in light gray) is coming soon. This is true for the differences between the 5-year and the 2-year bonds, as well as the 5-year versus the 3-year bonds.
It is also true for the closely monitored 10-year versus 2-year bonds as well as for the spread between the 10-year and the 1-year bonds, which has been negative each time before a recession in the United States since at least 1957.
The good news, somewhat, is that such inversions give a warning early enough. Most recession indicators appear between six months and a year before the start of a prolonged downturn in the economy. And the difference between interest rates on bonds is worrying at least a year earlier, and often two or more.
In the 1960s, the spread between 10-year and 1-year bonds was negative for three years.
So we can assume with a great deal of certainty that the next recession will hit the US by the end of 2020.
It is important to understand that this reversal of the curve does not cause a recession. The bond interest rate movement reflects a combination of Federal Reserve decisions as well as decisions to buy or sell to millions of investors. The Fed may try to change interest rates, but the central bank’s account is limited by its obligation to maximize employment but also to prevent too high inflation. At the same time, investors are trying to guess how the Fed will respond under different economic conditions and how they will change over the Fed’s response.
If the curve turns, that means the markets expect to reduce interest rates in the next one or two years for whatever reason. A big drop in interest usually means that we are in recession. Of course, turning the curve may not give a 100% prediction for the future.
EUR/USD technical analysis
EUR/USD is extending the daily correction higher and is now flirting with session tops in the 1.1360-1.1370 area.
The spot picks up the pace in the second half of the week after today’s ADP report noted the US private sector added 179,000 jobs during November, missing initial consensus. Still, in the US docket, weekly Initial Claims rose by 231,000, taking the 4-Week Average to 228,000 from 223,750. Additionally, the US trade deficit came in at 55.5 billion USD in October.
The currency pair EUR/USD continues to target the 1.1215 support zone as downside pressure remains intact. Support lies at the 1.1300 where a violation will aim at the 1.1250 level. A break below here will aim at the 1.1200 level. Further down, support lies at the 1.1150.
On the flipside, the currency pair may find resistance at 1.1350 level with a breakthrough there opening the door for further upside towards the 1.1400 level. Further up, resistance comes in at the 1.1450 level where a violation will expose the 1.1500 level. All in all, EUR/USD continues to face downside pressure.
GBP/USD technical analysis
The GBP/USD pair built on its goodish intraday bounce and refreshed session tops, around the 1.2775 area post-US ADP report. Absent negative Brexit headlines prompted some short-covering move around the British Pound and turned out to be one of the key factors behind the pair’s quick reversal from an early European session dip to the 1.2700.
Immediate resistance for GBP/USD pair is pegged near the level of 1.2800, above which a fresh bout of short-covering could lift the pair further towards the 1.2845-1.2850 support zone. On the flip side, any meaningful retracement now seems to find some support near the 1.2725 area and is closely followed by the 1.2700 round figure mark.