After an early New York swoon EUR/USD returned to positive territory on Tuesday and again threatened the 50% Fibo retracement of the 1.1692-1.1514 fall but could face a significant drop if a prior correlation to yield spreads reemerges.
For the moment, however, option expiries nL1N2S014W helped limit ranges.
From May 2020 until October 2021 spreads between German DE2YT=RR and U.S. US2YT=RR 2-year yields were highly correlated to EUR/USD.
The breakdown of the correlation which in October 2021 coincided with rallies in U.S. rates EDM2EDU2 as strong inflation drove investors to pull forward their expectations for Fed rate hikes, reflecting a view that the U.S. central bank would be more aggressive than the ECB.
Pricing in eurodollar and euribor short-term rates markets reinforce that view.
Investors are likely pay close attention to U.S. October CPI.
CPI estimates USCPI=ECI have risen from September's result.
Should October inflation surprise to the upside, U.S. rates could rally sharply, potentially bringing the dollar along if the DE-U.S.
spread recouples with EUR/USD.
EUR/USD could then complete its consolidation of the drop from September's high and break key support near 1.1500.
EUR/USD shorts would then target the 1.1200 area.
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