Looking at a chart of yield spreads between German bunds and US 10-year notes, it is interesting to note that the interest rate differential bottomed and rebound sharply about a week before the EUR/USD began its descent.
From a yield advantage of just 2 basis points on the 25th of November, the day EUR/USD topped out at 1.5144, rates began to back up sharply, accelerating after the better-than-expected US employment report on December 4. Since that time we have seen spreads balloon out in favor of the dollar as the market anticipates the Fed moving to snug up monetary policy before the ECB. A month ago, the expectation was exactly reversed.
The differential reached 37.5 bp yesterday and stands at 36 bp now, a day ahead of the Fed statement. If the statement reads like Bernanke’s speech of December 7 (uber-dovish, the spread may contract a bit) while any signs that growth and inflation are prompting the Fed to change its “rates will stay low for an extended-period” language, rates could gap out further, giving the greenback a further boost.
