EUR/USD consolidates in 1.1400 area in thin US holiday trade as markets mull hawkish Fed bets

• EUR/USD is consolidating in the 1.1400 area with US markets shut for Martin Luther King Jr Day.
• Hawkish Fed bets have seen implied yields on US bond futures rise, which might offer the dollar support.

FX market volumes are thinner than usual this Monday, with US markets shut for Martin Luthar King Jr Day, making for more tentative/subdued trading conditions across asset classes. EUR/USD is thus flat on the day in the 1.1400 area, as it consolidates above support in the 1.1380 area in the form of December/late-November highs and below last week’s near-1.1500 highs. Though the Fed has entered blackout ahead of the January 25-26 meeting next week, the debate over the outlook for Fed policy in 2022 and beyond remains the hottest topic in the market right now. With expectations for multiple 2022 rate hikes near-unanimous amongst analysts, the main debate is now how this will impact the economy and assets classes.

US bond markets are closed but the implied yield on the US 10-year treasury note future went as highs as 1.86% in earlier trade, whilst data last Friday from the CFTC showed speculator’s net short bets on the US 10-year future had hit its highest since February 2020. If speculators are right and US yields do resume their march higher this week, this could provide some much-needed assistance for the US dollar, which got battered last week on an unwind of crowded long bets. FX strategists at ING “remain of the view that we have not seen the peak of the dollar yet, and the balance of risks for EUR/USD is still skewed to the downside, primarily on the back of ECB-Fed monetary policy divergence”.

In terms of the main drivers of the euro in the week ahead, the bank notes that “apart from tomorrow’s ZEW Survey in Germany, there is no market-moving data in the eurozone this week... (thus) most focus will instead be on the minutes from the ECB December meeting, as well as speeches by Lagarde, Villeroy and Holtzmann”. The bank also warns euro traders to keep an eye on political developments in Italy, as “ongoing discussions around the candidates for the next President of the Republic (who the parliament is due to elect at the end of this month) risk affecting a BTP-Bund spread which has already widened by some 30bp since October”. A wider spread between German and Italian bond yields can weigh on the appeal of the euro, though ING think any such euro weakness would most likely be expressed through a weaker EUR/CHF.