•  Oil prices could spell end of range for Treasury yields
  •  But for now the yield premium is supportive of further EUR gains.

10-year Treasury yields have been stuck in a range for the past 6 weeks from 3.55% to 3.30%. This is one of the longest periods that Treasuries have been range-trading during the last 2 -years.

But high oil prices could be the catalyst for higher yields. Although WTI hasn't moved to the dizzy heights reached in Brent futures, it had a sharp reaction to the problems in Egypt and in the medium-term the trajectory for WTI prices looks higher.

WTI and 10-year yields tend to have a tight positive correlation as you can see on the chart below (which has been normalised and indexed to a factor of 100 to show how both assets move together).

WTI crude (orange line) and US 10-yr Treasury yields


Thus, a pick-up in WTI prices could see Treasury yields head towards 4%.

Fed could get in the way of higher Treasury yields

But... the Fed's obsession with unemployment and focussing on core inflation (rather than headline like the ECB and BOE) will keep the Fed funds rate depressed for an extended period and the possibility of more QE further down the line on the table. This has the potential to disturb the oil/ yield relationship in the future.

For now though, the yield differential between the Europe and the US (using German yields as the benchmark) is at its widest level for 2.5 years, which is supportive of further EURUSD gains. ECB President Trichet's press conference later today will determine whether Europe can maintain its yield premium over the US and EURUSD can continue its march to 1.40. Hawkish comments from Trichet would be the trigger.

Leading up to the ECB meeting, the yield spread has pulled back a little and there is some apprehensiveness in the markets preventing new longs forming in EURUSD. So expect fireworks this afternoon. Trichet kicks things off at 1330 GMT.

German 2-yr - US 2-yr government bond yields (white line) and EURUSD


Best Regards,

Kathleen Brooks| Research Director UK EMEA | FOREX.com

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