The narrowing gap between US and German bond yields, coupled with a disappointing start for the S&P 500 index, is boosting capital flight from North America to Europe and is facilitating the EURUSD rally. Let’s discuss this topic and make a trading plan.
The article covers the following subjects:
Major Takeaways
- The US dollar has posted its worst start since 2008.
- Distrust of Trump’s policies is driving capital flight from the US.
- Fiscal stimulus in Europe is a long-term commitment.
- If the EURUSD grows above 1.091, long trades can be considered.
Weekly US Dollar Fundamental Forecast
Recently, Treasury Secretary Scott Bessent has described the US dollar’s worst start since 2008 as a natural “adjustment.” According to Bessent, the greenback was significantly overvalued after the election day, and what is happening now is a pattern. The Treasury Secretary was modestly silent on the reasons why. It’s hard to admit an uncomfortable truth. Investors are losing confidence in Donald Trump’s policies and fleeing to Europe, which is opening the taps on fiscal stimulus. Against this backdrop, the EURUSD pair is rallying.
US Dollar Performance
Source: Bloomberg.
It was widely anticipated that Friedrich Merz would reach an agreement with the Greens and pass the government spending increase packages. The final decision will be made during the vote in the Bundestag on March 18th, and the markets consider this event to be more important than the Fed meeting because it will provide significant support for the EURUSD rally, which is expected to rise in response to the 50 basis point increase in German bond yields in March.
The differential between German and US bond yields has narrowed to 140 basis points from 230 basis points three months ago. Societe Generale forecasts that the differential will shrink to 50 bps by the end of 2025. The last time the index was at this level was in 2013. At that time, the EURUSD exchange rate was 1.37.
US-Germany 10-Year Bond Yield Spread
Source: Bloomberg.
The foreign exchange market is reinforcing the view that fiscal stimulus measures in Germany and the European Union are not a one-time measure, as was the case during the pandemic. These measures are laying the foundation for a long process of European economy acceleration, which increases the attractiveness of assets issued within the currency bloc and promotes capital inflows. Notably, capital inflows from North America, particularly from the policy-driven developments in Donald Trump’s administration, are a significant component of this trend.
During the presidential election in November, investors had anticipated tax cuts and deregulation, which would have been beneficial for the S&P 500 index and the US dollar. However, the beginning of 2025 has been challenging. Tariffs and trade wars could potentially lead to a difficult economic environment for the US.
This is particularly concerning, given the interconnected nature of the global economy. The stock market decline is partly due to the weak economy, but plummeting stock indices also affect US GDP. Harvard University estimates that a 20% slump in the S&P 500 in 2025 could reduce gross domestic product by 1%. Notably, the wealthiest 10% of US households account for half of all consumer spending. If in 2023–2024 they were spending freely due to a broad stock index rally, now the process is reversing.
Weekly EURUSD Trading Plan
The narrowing economic growth divergence and capital spillover from the US to Europe set the stage for a continuation of the EURUSD rally. The question remains whether the correction has ended. Long trades can be opened if the pair breaks through the resistance level of 1.091.
This forecast is based on the analysis of fundamental factors, including official statements from financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also considered.
Price chart of EURUSD in real time mode
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