I want to share something with you that I recieved today in my email from one of my co-workers. He actually works on the rates side of things, focusing particularly on the US Treasury market. The content of the email, though, has clear forex market implications. I offer it up as an example of the sorts of things that market professionals look at and talk about that the vast majority of retail traders would never even think about.

The ECB’s money market operations have effectively delivered a significant tightening of monetary policy especially when compared to the effective easing of policy that has occurred in most other economies over the last month.

The result has been a substantial rise in the EUR yield advantage that the market has not been able to ignore.

The ECB policy of shifting the slide-rule on their 1% rate from 12mth to 3mth terms has lifted the overall money market yield curve. The 1% benchmark rate level now means more to where short term money market rates trade.

With less term funding, this has put upward pressure on all yields across the front end of curves. 2yr bund and swap rates rose a further 7.5bp today. Over the course of the last month, the USTr-Bund 2yr yield spread has moved in favour of the EUR by over 30bp to +5bp. The 2yr swap rate spread has moved up by 35bp to +44b in favour of the EUR. In a global environment of falling yields over the last month, EUR’s yields have risen against virtually all comers. The chart below shows the EUR/USD compared to the 2yr yield spread.

There are some complex elements to the commentary above, but the bottom line is that the recent technical moves on the funding side of things by the ECB has created a rate crunch on the short-end, and when short rates go up it tends to make a currency more attractive. Looked at a chart of EUR/USD lately?

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