The euro profits at the expense of the dollar (Afternoon analysis 27.02.2020)

US Treasury bond yields are dropping ever lower, but also the yield differential to German bonds is falling. Today it was the lowest since September 2017, which also increased demand for the euro. The EUR/USD exchange rate is above 1.10, and the main pair moves toward 4.33.

Macroeconomic data can deteriorate the market sentiment

Sentiment in the broader market worsened in the afternoon. One hour after the start of trading on the New York Stock Exchange, the main US indexes were losing about 3-3.5 percent each, while most of their European counterparts were losing about 4 percent each. The escape into safer asset classes led to a deepening of the US Treasury bond yield falls.

The yields of bonds maturing in 2 years are rapidly approaching the 1% limit, and within an hour after the start of the session in the US they dropped to about 1.03%. Just a week ago, the cost of 10-year debt was just above 1.40%. Such a rapid and strong drop in US debt yields due to the impact of the coronavirus has dramatically increased market expectations for interest rate cuts this year. The market is currently pricing (based on Fed rate contracts) already three Federal Reserve (Fed) interest rate cuts by the end of the year.

The sharp reduction in the cost of US debt has also reduced the difference with the eurozone. The spread between US and German 10-year bond yields fell to its lowest level since September 2017, (around 1.8 percentage points), which also exerted demand pressure on the euro in relation to other currencies. The EUR/USD quotations increased above 1.10 for the first time since February 6. The common currency also gained in relation to, among others, globally stronger franc or yen today, which reacted to an increase in risk aversion.

As a result, the EUR/PLN exchange rate also increased to approx. 4.3260, i.e. to the highest level since the end of November last year, and also close to the upper quotation level since September. Financial instruments are currently reacting to the incoming information on the spread of coronavirus, but hard macroeconomic data which could show the actual impact of coronavirus have not begun to flow yet. Therefore, it is likely that in the following weeks and months, there will be a worsening of sentiment caused by this, as well as a reversal of the current falls. On Saturday, the first data on PMI activity indexes from China will be released, which may cause worsening of sentiment at the beginning of next week.

Tomorrow's preview

Apart from the impact of the coronavirus reports, the most important event on Friday may be the publication of macroeconomic data from the USA. At 2:30 p.m., January's balance of foreign trade in goods (consensus: - 68.5 billion USD), the level of wholesale stocks (consensus: +0.1% month-on-month), although the most important for the market will be the readings of income (consensus: +0.4% month-on-month), expenditure (+0.3% month-on-month), and PCE core inflation (consensus: 1.7% year-on-year). The US currency is currently under strong supply pressure due to falling US Treasury bond yields and increasing likelihood of interest rate cuts this year. However, readings exceeding the consensus could slightly cool down market expectations and strengthen the dollar.