- An aggressive fiscal spending proposal by Germany has attracted bullish animal spirits into EUR/USD.
- A significant rally in the longer-end German Bund yields is likely to alter ECB monetary policy guidance towards a “less dovish stance.”
- The three-month rally in the EUR/USD has reached overbought condition, at risk of a minor corrective pull-back below 1.0885/0940.
In the upcoming European Central Bank (ECB) meeting on Thursday, 6 March, where market participants are expecting another 25 basis points (bp) cut, its sixth reduction to reduce the key policy deposit rate to 2.50%, also a two-year low.
Our prior report dated 4 December 2024 highlighted, “The medium-term downtrend of EUR/USD remains intact, but a mean reversion corrective rebound may occur first below 1.0770 key medium-term resistance.”
The EUR/USD has rebounded by 6.2% as expected from its intraday low of 1.0178 printed on 13 January to Thursday, 5 March, with the current intraday level of 1.0811 at this time of the writing. The “Trump Trade” of a stronger US dollar ex-post US presidential election riding on the coattails of rising longer-term US Treasury yields due to deeper corporate tax cuts that tend to widen the US budget deficit as well as a potential myriad of trade tariffs against major US trading partners has been evaporated.
The EUR/USD is now trading at levels close to the day of the US presidential election on 5 November 2024. Geopolitics and a change of fiscal policy stance in Germany are the key catalysts driving the ongoing rally in the Euro.
New Aggressive Fiscal Stimulus Plan From Germany
Germany’s newly elected incoming Chancellor Friedrich Merz has campaigned on a more expansionary fiscal policy, a radical shift away from his predecessors that championed on fiscal austerity policies.
Merz has proposed the biggest government spending spree since reunification in 1990. Defense and infrastructure outlays could amount to approximately 1 trillion euros, around 20% of GDP. Also, the new coalition government is set to relax the Berlin “debt brake” fiscal rule in the constitution to exempt defense spending above 1% of the GDP output.
Geopolitics also play a significant role in the latest crafting of an aggressive defense expenditure plan for Germany. US President Trump has signaled that the US is not willing to provide a solid security guarantee to Ukraine in any US brokered peace deal to end the three-year Russia-Ukraine war.
Higher Fiscal Spending Allows ECB to Be Less Dovish
Fig 2: 10-year yield spread of German Bund/US Treasury Note with EUR/USD as of 6 Mar 2025 (Source: TradingView)
The ECB may provide a less dovish guidance after today’s monetary policy decision meeting during President Lagarde’s press conference, as Germany’s aggressive expansionary fiscal policy can do the “heavy lifting” to reverse the Eurozone’s sluggish growth trajectory in the past two years.
Hence, the ECB is likely at the tail-end of its current interest rate cutting cycle where the German Bund market has responded strongly to a potential upcoming change in Eurozone’s monetary policy stance. The longer-end 30-year German Bund yield jumped by around 25 bps to 3.08% on Wednesday, 5 March, its biggest daily increase since October 1998.
The 10-year yield spread between the 10-year German Bund and the US 10-Year Treasury Note has tracked closely with the movement of the EUR/USD in a direct correlation fashion (see Fig 1).
The current uptick in the 10-year German Bund}}/US Treasury Note yield spread may see further upside to test its key long-term secular resistance at -1.35%, which translates to a further potential upmove in the EUR/USD towards a parallel long-term secular resistance level of 1.1040 in the coming weeks (see Fig 1).
Overbought Condition Reached In EUR/USD, At Risk of An Imminent Pull-Back Below 1.0885/0940
Fig 2: EUR/USD medium-term & major trends as of 6 Mar 2025 (Source: TradingView)
In the lens of technical analysis, price actions of highly liquid traded instruments do not move vertically but oscillate within trends.
The recent three-month rally seen in the EUR/USD has reached an overbought condition as indicated by its daily RSI momentum indicator, and its price actions are coming close to a former major ascending trendline support from 3 October 2023 low now turns into a pull-back resistance at 1.0885/0940.
Thus, the next probable move in the EUR/USD is likely a minor corrective pull-back within a medium-term uptrend phase. The first support to watch in this potential minor corrective pull-back sequence will be at 1.0730 (also the 200-day moving average), followed by the 1.0600 key medium-term pivotal support (also the 20-day moving average) to maintain the current medium-term uptrend phase in place since the 13 January 2025 low (see Fig 2).
On the flip side, another swift rally above 1.0940 sees a squeeze up towards the 1.1010/1040 long-term secular resistance.