Dollar in charge as Euro and Pound hit six-month lows

The US dollar scaled a 10-month high against its major peers on Wednesday, pushing the Euro and Sterling to 6-month lows and keeping the Yen deep in intervention territory, as the prospect of higher-for-longer US rates gripped markets.

US Treasuries stabilised after their recent heavy selloff, though yields remained near 16-year peaks, keeping the greenback solidly bid.

The Euro was last 0.1% lower at $1.0522, after hitting a six-month low of $1.0555 earlier in the session.

The single currency was on track to lose more than 3% for the quarter, its worst quarterly performance in a year.

Sterling was also down 0.1% at $1.2149 after hitting a six-month trough of $1.2135 earlier on Wednesday, and was headed for a quarterly loss of more than 4%.

The US dollar index, meanwhile, peaked at a 10-month high of 106.32.

"It's clear now that markets see higher long-term yields in the US for a longer period. That's the main driver for the dollar here," said Dane Cekov, senior FX strategist at Nordea.

"It's been a while since we've seen 10-year yields at 4.5%."

Fed officials have in recent days flagged the possibility that the central bank would need to raise interest rates further, after it kept rates steady last week but stiffened its hawkish monetary policy stance.

That has sent US Treasury yields to multi-year highs as money markets have adjusted their expectations of where US rates could peak, and for monetary conditions to remain tighter for longer than initially thought.

The benchmark 10-year yield was last at 4.503%, after hitting a 16-year high of 4.566% in the previous session. The two-year yield stood at 5.047%.

Euro To dollar forecast

Foreign exchange analysts at ING Bank suggest the Euro (EUR) it tipped to fall against the US Dollar (USD) in the near term outlook, targeting a floor of 1.05, citing "the growth differential between the eurozone and the US, a lingering high real USD rate and an unstable risk environment point."

However, the FX strategists warn that a deeper drop to the 1.02 level can't be ruled out.

Central to this currency forecast is the rising strength of the US Dollar, propelled further by the narrative of the Federal Reserve.

As higher yields emerge, a mirror effect is witnessed in the treasury yields, and the forex market feels this pulse distinctly.

"We simulated a scenario where the 10-year Treasuries hit 5.0%, based on the past year of EUR/USD coefficients. We estimate the pair would be trading around 1.02 with 5.0% 10Y yields," says Francesco Pesole, FX Strategist at ING Bank.

This projected scenario implies a roughly 3.5% reduction from the currency pair's current position, echoing the trend seen when UST 10Y yields moved from 4.0% to their present 4.50%.

"The rewidening of the USD:EUR short-term rate differential in the past few months has been another driver of EUR/USD depreciation," the analyst adds.

Swap rates

This rate expansion primarily stems from the uptick in US swap rates.

This progression is uninfluenced by any significant alterations in EUR rates.

Given the underlying volatility of US swap rates due to the Federal Reserve's actions, it is anticipated that the EUR:USD short-term swap rate differential will be primarily propelled by the dollar's performance.

Amid this backdrop, it becomes pertinent to assess the potential moves and their implications on the EUR/USD currency pair.

"Expectations of Fed easing... have been driving most dollar moves of late, and markets are now attaching a greater weight to the 2024 dot plot projections," Pesole said.

There's an evident shift in market sentiments with market players leaning towards the 2024 dot plot outlooks, a strong indication of the Federal Reserve's future actions.

A more granular view reveals that the gap between the current end-2024 implied rate and the recent median dot plot for that year isn't as vast as before, limiting the scope for further hawkish repricing.

Moreover, the strategist points out that the Federal Reserve has limited opportunities left this year to stay true to its "promise" to increase rates.

"The room for a hawkish repricing is now substantially smaller than it was in June," the analyst added.

There's a palpable expectation within market circles of the US back-end yields retaining their high trajectory.

Despite this, predictions around the EUR/USD exchange rate remain cautious.

Potential bearish pressures on the dollar's shorter end may be limited, but the longer-term implications of US bond actions cannot be discounted.

"All in all, we estimate 1.02 as the most likely bottom for EUR/USD in a scenario where the US bond sell-off continues," Pesole said.