The EUR/USD has been declining amid rising Treasury yields. However, the Fed’s hawkish stance could limit further gains in Treasury yields while providing additional support for the US dollar. Let’s analyze this situation and develop a trading plan.
The article covers the following subjects:
Major Takeaways
- The Fed can bring yields back below 5%.
- The US dollar will strengthen if the Fed surprises the market.
- The greenback could break the correlation.
- A sustained move above 1.1555 will offer a buying opportunity on the EUR/USD.
Daily Fundamental Forecast for Dollar
The Treasury’s buyback program has failed to halt the rise in Treasury yields, with the 10-year Treasury yield reaching its highest level since 2007. Perhaps the Treasury’s bond purchases won’t end the yield rally, but a Fed rate hike followed by hawkish rhetoric from Kevin Warsh will. How will the US dollar react? That remains a big mystery. As a result, investors are closing out positions ahead of the FOMC announcement, allowing the EUR/USD to find its footing.
Meanwhile, Scott Bessent argues that the Treasury’s buyback program is working and that, without it, Treasury yields would be even higher. However, around half of the asset managers surveyed by Bank of America believe the program is ineffective. Moreover, 29% say that Treasury buybacks actually push rates higher rather than lower. Given the growing correlation between the US dollar and Treasury yields, one might expect the dollar’s reaction to the Fed’s decision to mirror the bond market. In reality, the relationship is far more complicated.
Correlation Between US Dollar and 10-Year Treasury Yield
Source: Bloomberg.
If the Fed refrains from raising rates—or hikes rates and then offers little clarity on the prospects for further monetary tightening—long-term Treasury yields may move even higher. Investors may conclude that the central bank is not prepared to fight inflation aggressively enough and, in response, demand higher yields to compensate for the risk.
In the last eight instances, the 10-year Treasury yield did not remain above 5% for an extended period. On average, it took just 12 days for yields to fall back below that threshold. The Fed now has an excellent opportunity to confirm this historical pattern. The problem is that Kevin Warsh’s reluctance to provide clear forward guidance could itself be interpreted as dovish rhetoric, potentially pushing Treasury yields higher. Will the US dollar follow suit?
Market Expectations for Fed Funds Rate
Source: Bloomberg.
The derivatives market assigns a 92% probability to a Fed rate hike in September and puts the odds of two rounds of monetary tightening in 2026 at 79%. In other words, the market has already largely priced this scenario into EUR/USD quotes. For the pair to extend its decline, the probability of three rate hikes would need to increase. At present, that probability stands at just 30%.
Such a shift could be reflected in either the Fed’s updated FOMC projections or more hawkish remarks from Kevin Warsh. Either way, the US dollar would likely strengthen. However, if the FOMC signals two rate hikes and the Fed chair offers no new guidance, the greenback could come under pressure.
Daily Trading Plan for EUR/USD
If the EUR/USD pair settles above 1.1555, it could offer a buying opportunity. If bulls fail to defend this level, consider selling the pair.
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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