USD/JPY falters, EUR/USD awaits French bond verdict

• US 10-year yields stage dramatic 13bp intraday reversal
• USD/JPY breaks triangle support but lacks follow through
• French fiscal concerns disrupt euro-yen correlation patterns
• French bond reversal could help EUR/USD break resistance

The US dollar reversed lower overnight, coinciding with similar moves in crude oil futures and benchmark US 10-year Treasury yields.

That saw USD/JPY break its uptrend from the low set in mid-September, hinting a broader trend change may be underway for the big dollar.

The question now is whether EUR/USD, which has been battling idiosyncratic headwinds sparked by renewed concerns about the French fiscal outlook, could follow the move we saw in the yen on Thursday.

Crude retreats, Treasury yields tumble

Rather than one specific catalyst, several factors were behind the reversal in US Treasury yields, with the largest move coming after remarks from President Donald Trump indicated that military action against Iran would be delayed until at least after November's midterm elections.

That saw some of the geopolitical risk premium that had been building in crude futures unwind, with US Treasury yields following suit, continuing the relationship we've seen recently between oil prices and the long end of the curve.

Source: LSEG

Benchmark US 10-year yields fell from a session high of 5.354% to 5.223%, a reversal of more than 13 basis points, helped by another strong US Treasury auction, this time for 30-year debt, which stopped through prevailing market levels by more than two basis points.

Given the strong relationship between the US dollar and Treasury yields recently, a continuation of the move lower in yields may result in similar weakness in the dollar.

Euro-yen correlation breaks down

While the reversal in US Treasury yields helped USD/JPY break its uptrend, we've yet to see a similar technical development in EUR/USD, which remains below downtrend resistance.

Source: LSEG

On a four-hourly timeframe, we've seen a substantial breakdown in the moderately positive relationship that had existed between the euro and yen against the US dollar earlier this year.

That largely reflects renewed market angst over the French fiscal outlook, which has seen the yield premium on French 10-year government debt over German equivalents blow out to levels not seen since 2011, during the European sovereign debt crisis.

French yields could provide catalyst for EUR/USD

While those concerns are far from resolved, what may matter in the short term is whether we see a similar reversal in French long-end yields, catching up with the move seen in US Treasuries overnight.

If so, the correlation analysis below suggests it could provide the catalyst for a potential EUR/USD breakout.

Source: LSEG

Over the past five and 10 sessions, EUR/USD has shown a strong inverse relationship with French government bond yields, particularly at the longer end of the curve. Correlations with French 10-year yields stood at −0.87 and −0.80 respectively, with similarly strong negative readings against 30-year yields of −0.83 and −0.69.

Interestingly, the relationship appears strongest with outright French yields rather than changes in the slope of the 2s30s curve, despite the rapid increase in term premia associated with renewed fiscal concerns.

USD/JPY triangle support breaks

Source: TradingView

As seen on the USD/JPY four-hourly chart above, the unwinding of US Treasury yields has seen the pair break triangle support that had been in place from the lows set in late September.

While we saw a solid bounce from just above 157.50, mirroring similar price action earlier this month, the inability to successfully stick a breakout above triangle resistance at 158.45 suggests directional risks for the pair may be skewing sideways to lower.

The overnight low of 157.52 is the first downside level of note, followed by 157.00 and 156.40, the latter having acted as both support and resistance over recent weeks. A move beneath 156.40 would open the door for a potential move towards a more pronounced support zone between 155.50 and 155.00, which absorbed ample selling pressure earlier this year during several intervention episodes.

Should the rebound seen late in the US session continue, topside levels of note include 158.45 and 159.00.

The message from the oscillators is largely neutral. RSI (14) sits marginally below the neutral 50 level, while MACD has crossed below its signal line from above but remains marginally in positive territory. More emphasis should therefore be placed on the price action rather than retaining a specific directional bias.

EUR/USD downtrend resistance under threat

Source: TradingView

Turning to EUR/USD on the four-hourly timeframe, the pair has been in a strong downtrend from the high set in early September.

However, while the broader trend is clear, it's interesting to note that we've seen a series of marginally higher lows since the pair bottomed at 1.1162 on October 5, with the latest coinciding with a rebound towards downtrend resistance.

The intersection of that downtrend with 1.1220, a minor level that has acted as both support and resistance over the past week, now looms as the immediate level to watch overhead.

A sustained break above this resistance zone would bring 1.1275, 1.1285 and then 1.1312 into view, levels that coincide with minor swing highs or former support.

However, if EUR/USD fails to break the downtrend, focus would shift back to price action around 1.1173, where the pair has bounced on several occasions so far in October. A break beneath that level would put the October 5 low of 1.1162 back in focus.

The oscillators suggest the prior strong downside pressure continues to ease, with a series of higher lows in RSI (14) since early October. While we've yet to see a higher high established, the risk of a breakout appears to be building, although both RSI (14) and MACD are delivering more cautionary signals to bears than outright bullish signals for buyers.