How quickly the scenery changes on Forex! Just a couple of weeks ago, investors' attention was focused on the dynamics of Treasury bond yields. The rise in rates on 10-year bonds to 5% was seen as a regime change and a rationale for the strengthening of the U.S. dollar. However, at the end of November, the bond market took a back seat, and quite unjustifiably.

According to TD Securities research, there are "bear" smoothing regimes when short-term bond yields rise faster than long-term ones, and "bull" smoothing regimes when everything happens the other way around. In the first case, investors are concerned about high inflation and the Federal Reserve's monetary restraint. This regime is favorable for the U.S. dollar, which the American currency demonstrated in 2022–2023.

On the contrary, the bull smoothing regime is characterized by a faster rise in long-term bond rates than in short-term ones. Investors are not worried about the future of the U.S. economy and the tightening of the Federal Reserve's monetary policy. Historically, in such periods, the USD index has fallen.

However, what about the decline in bond yields? If it happens more quickly on 10-year bonds than on 2-year bonds, investors are betting on a soft landing. This creates a tailwind for risky assets and puts pressure on the bears on EUR/USD, which is exactly what is happening now.

Dynamics of U.S. Treasury yields

For the main currency pair to fall again, the bear smoothing regime must return. This is only possible in the case of an acceleration of inflation in the U.S., which will bring back discussions about the resumption of the Federal Reserve's monetary tightening cycle. In all other cases, EUR/USD will go upward in the medium and long term.

On the other hand, the intervention of the Federal Reserve can slow down this process. According to Goldman Sachs, there are risks of disappointment with the further dynamics of GDP and inflation in the U.S., which will hit the rally of the S&P 500 and other stock indices. According to Jefferies International, one of the drivers of the stock market correction is resistance from central banks.

The markets may be reacting too sharply to the risks of a rate cut in federal funds for 2024. Expectations of massive monetary stimulus push up the S&P 500; however, a decline in inflation does not mean a decline in borrowing costs. The Federal Reserve can sit on the plateau for as long as it wants, casting doubt on the rally of EUR/USD, at least in the short term. The most likely scenario is seen as the consolidation of the pair with subsequent recovery of the upward trend.

Technically, on the daily chart of EUR/USD, the bulls managed to storm the pivot level at 1.094 and move the pair quotes to August highs. However, if a pin bar forms on the November 21 trading, the euro should be sold from $1.093. Conversely, closing above $1.094 will allow us to adhere to the previous buying strategy with a target at $1.103.