Bond yields across European countries are rising faster than in the US, encouraging investors to buy the EUR/USD on expectations that the ECB may tighten monetary policy. However, the factors driving the rise in European bond yields may not necessarily be positive for the euro. Let’s assess the implications for the EUR/USD pair and develop a trading plan.
The article covers the following subjects:
Major Takeaways
- Political risks in Europe continue to rise.
- The ECB appears to be more hawkish than the Fed.
- Investors are awaiting US inflation data.
- Short trades can be opened on a rebound from 1.166.
Weekly Euro Fundamental Forecast
The EUR/USD is hanging on the bond market’s every move. Yields on European bonds are rising faster than those on US Treasuries, suggesting that the ECB may be taking a more hawkish stance than the Fed. This provides a compelling case for buying the euro. In other words, the market expects Christine Lagarde not only to raise rates in the coming days but also to signal that the monetary tightening cycle is far from over. By contrast, expectations for two rate hikes by the Fed continue to fade.
Government Bond Yields
Source: Bloomberg.
The problem is that the rally in bond yields is only a pretty picture. Behind the scenes, what’s driving it is hardly positive for the EUR/USD. When yields rise, bond prices fall as investors sell their holdings. French and Italian debt is bearing the brunt of the selling, as both countries grapple with mounting budget pressures. Germany is increasingly coming under pressure as well, with 30-year Bund yields surging to their highest level since 2011.
Friedrich Merz has not only suffered a setback at the regional elections—but he has also become something of a scapegoat within his own party. CDU representatives have pointed to the sharp decline in the chancellor’s approval rating, now at just 15%, and blamed him for the electoral defeat. Germany could ultimately face a vote of no confidence followed by snap parliamentary elections, although Morgan Stanley considers this a tail risk. The more likely scenario, according to the current market narrative, is the AfD forming a minority government.
Rising political risks, higher oil and gas prices, and the resulting threat of accelerating inflation could force the ECB toward a tighter monetary policy stance. Together, these factors are triggering a sell-off in European bonds and pushing yields higher. At first glance, that rise in yields makes European fixed-income assets look more attractive, providing support for the EUR/USD.
The contrast with the Fed is becoming even more striking. The probability of two Fed rate hikes in 2026 has fallen from around 50% before the latest US jobs report to roughly 42%, while the probability of a September hike remains around 60%.
Market Expectations for Fed Rate Hike
Source: Bloomberg.
Thus, EUR/USD bulls have been carried away by the rally in bond yields, overlooking the more important question: what is driving those yields higher? In Europe, the answer lies largely in political uncertainty and fears of a repeat of the energy crisis. In the US, by contrast, rising yields reflect confidence in the economy’s resilience. After all, who said that an economy as strong as the US couldn’t withstand Treasury yields of 5%? By historical standards, that level is hardly extraordinary. The recent rise in yields may simply represent a return to normal after decades of financial repression, rather than a sign of deteriorating economic fundamentals.
10-Year US Treasury Yield
Source: Bloomberg.
The Forex market may be making a mistake by buying EUR/USD—and the upcoming US inflation report could force it to confront that mistake.
Weekly EURUSD Trading Plan
The euro’s rally appears increasingly out of touch with reality. A pullback from the 1.166 level—or a return to the 1.158–1.164 trading range after the pair returns below its upper boundary—could trigger a wave of selling in the EUR/USD.
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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