Euro weakens vs dollar as Treasury yields pick up on stimulus talks

The euro hovered around a two-week low versus the dollar as the U.S. currency held strong on Tuesday, boosted by slightly higher Treasury yields, while political uncertainties in Italy also kept the common currency subdued.

Yields on U.S. benchmark 10-year government bonds pulled away from three-year lows, helped in part by the prospect of Germany ditching its balanced budget rule to boost spending and on more economic support measures by China.

Yields fell last week to cause an inversion of the short-dated and long-dated yield curve, sending alarms through financial markets given that several recessions in the past have been preceded by yield curve inversions. The curve of the two-year and 10-year Treasury yields was slightly steeper on Tuesday.

“The dollar is higher across the board, tracking the rebound in yields. The prospect of Germany embarking on stimulus was the turning point and the dollar has regained momentum since,” said Yukio Ishizuki, senior currency strategist at Daiwa Securities.

The dollar index was flat at 98.385 after rising to a two-and-a-half week high of 98.40 earlier.

The euro was also flat at $1.1078, but not far from the $1.1066 low it reached on Friday on lingering concerns over political developments in Italy.

Prime Minister Giuseppe Conte is set to address parliament on Tuesday afternoon (1300 GMT) to defend his record. He might hand in his resignation immediately afterwards or could instead wait for a formal vote to make it clear he is being unseated by the far-right League.

A vote has not yet been scheduled and there is widespread uncertainty over how the political turmoil will end Deputy Prime Minister Matteo Salvini pulled the plug on the ruling coalition Movement earlier this month, hoping to trigger early elections that would likely see him crowned as prime minister.

“The possible success of the no-confidence vote in Italy today could push euro/dollar towards and even below the psychological 1.1000 level today,” said Chris Turner, head of forex strategy at ING.

“Though falls are unlikely to meaningful or persistent,” he said, “because the negative spillover into the euro from periods of political uncertainty in Europe has been somewhat limited over the past year.”

Elsewhere, a stronger dollar pushed the offshore Chinese yuan lower to have it match a six-day low of 7.0770 against the greenback earlier, though China’s offshore yuan was last trading neutral at 7.0708.

The pound was down by 0.3% both against the dollar and the euro, last at $1.2092 and at 91.55 pence against the euro.

British Prime Minister Boris Johnson made new waves by writing to European Council President Donald Tusk on Monday to propose replacing the Irish backstop with a commitment to put in place alternative arrangements by the end of a post-Brexit transition period.

Johnson will meet both French President Emmanuel Macron and German Chancellor Angela Merkel during the week and is also planning to meet Ireland’s Prime Minister Leo Varadkar in September.

Market focus should shift to the annual symposium of global central bankers starting on Friday at Jackson Hole, Wyoming.