Breakthrough! Euro's Surprise Attack on the US Dollar
The US Dollar Index has once again broken through key levels, while the Euro has rebounded to 1.1580 due to the ceasefire in Israel and Palestine. NATO has reached a historic defense spending agreement, pushing the Euro to a new high for 2021. It is expected that European defense spending will increase by nearly $700 billion over the next decade, stimulating the economy. Meanwhile, Powell did not cut interest rates, leading to increased market expectations for rate cuts, which has put downward pressure on the US Dollar Index. The Renminbi has underperformed, with USDCNH once approaching 7.15 before rebounding, resulting in a significant drop in the Renminbi Index
The US Dollar Index has broken 98 again. The first break two weeks ago was barely reversed by missiles sent from Israel, and this time, a downward break seems inevitable.
First, who is the main cause of this round of break?
(1) Euro
Taking advantage of the ceasefire between Israel and Iran, the Euro returned to the pre-war level of around 1.1580 on Monday evening. On Wednesday evening, NATO reached a historic agreement to significantly increase defense spending from the current target of 2% to 5% of GDP by 2035, giving the Euro a boost and reaching a new high since October 2021.
What does this additional 3% mean? A simple calculation: according to the total GDP of all European NATO member countries exceeding $23 trillion in 2024, an increase of 3% represents an increase of nearly $700 billion in defense spending. Although it is a ten-year effort, this will undoubtedly inject new momentum into the European economy, echoing Germany's recent announcement of increased fiscal stimulus. For investors who were previously worried that European fiscal stimulus would become a mere empty promise, seeing the efforts of various European governments now makes them naturally willing to buy Euros.
Chart: EURUSD weekly chart shows a new upward trend
(2) US Dollar Interest Rates
Powell boldly faced Congress on day 2, still showing no intention of cutting interest rates. Trump, in a fit of anger, mentioned that there are already three to four candidates who might serve as the next chair of the Federal Reserve and threatened to nominate someone early. The candidates he favors, former Fed governor Warsh, Director of the National Economic Council Hassett, current Fed governor Waller, and Treasury Secretary Basant, all share the common trait of supporting interest rate cuts, aligning with Trump's wishes.
As a result, the market continues to increase pricing for interest rate cuts within the year, with the 1Y SOFR dropping to a recent low of 3.88%, which also puts pressure on the US Dollar Index.
Secondly, how does the Renminbi perform amid the downward break of the US Dollar Index?
It has fallen behind again. Although, after the midpoint rate hit a new low, there was a wave of upward appreciation in the onshore market yesterday morning, with USDCNH once approaching 7.15. However, soon after, there was a strong buying interest domestically pushing from 7.1565 all the way up, leading to both USDCNH and USDCNY reaching new intraday highs by the close of the Asian session. Correspondingly, the Renminbi index plummeted, with EURCNH once breaking 8.4, approaching historical highs, which is truly astonishing Finally, what is the market outlook for the next step?
- The break of the US Dollar Index is undoubtedly confirmed, with a potential drop to the 95 level;
- EURUSD has broken through previous highs, with resistance above dissipating, possibly targeting 1.20;
- Considering the recent surge in the stock market and the decline of the US Dollar Index, there is little room for the depreciation of the Renminbi, and the probability of appreciation continues to rise. However, given the strong buying power, the pace is very controllable, and it is expected that the fluctuation range will slowly move downwards. With a concentration of risk events in July, such as potential positive negotiations between China and the US (e.g., fentanyl tariffs), the possibility of rising to 7.1-7.12 cannot be ruled out. It is recommended that companies engaged in foreign exchange settlement pay attention to exposure risks and increase hedging ratios when prices are high.
Chart: Shanghai Composite Index hits a new high for the year
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