US Signals Recession, but Eurozone "Rebounds", Will EUR/USD Flip?

Huitong Finance APP News—On Tuesday (August 5), the euro-dollar exchange rate fell slightly, hovering around 1.1541, with a decline of approximately 0.2%.

The second-quarter GDP in the eurozone achieved a positive growth of 0.1%, exceeding expectations of zero growth, and the composite PMI is expected to rebound to the expansionary zone, indicating that economic activity is gradually stabilizing.

Meanwhile, the US Labor Department's non-farm data fell significantly below expectations, triggering a sense of caution on recession, leading to increased short-term bond buying and pushing up bond prices, while long-term bond yields rose as investors sought higher returns to offset future inflation risks.

The yield curve is rapidly becoming steeper, which may become a signal for US recession.

The 10-year Treasury yield has dropped almost back to its "liberation day" (April 2) level, having previously risen sharply due to risk aversion and the risk of economic recession.

However, future concerns are more about inflation pressure rising, even if it's slightly above the expected level.

The possibility that inflation reaches 4% in the second half of 2025 is quite high due to tariff pressure. Even if long-term yields choose not to worry about fiscal red ink and financing issues, they cannot completely ignore a 4% inflation rate.

The key question is whether the 10-year Treasury yield can fall back to around 4% or lower when inflation reaches 4%. This is possible but will be affected by the negative factors of inflation and red ink.

The forward-looking perspective suggests that even if short-term yields drop, long-term yields may still rise due to future inflation expectations.

As for the eurozone, economic growth is strong and supports a rate hike outlook.

In contrast to the US, the eurozone's data seems to be recovering trendwise, which itself provides reasons for a rate hike outlook.

The "liberation day" made the outlook darker, but subsequent data has continued to exceed expectations. Not only soft data, but also the second-quarter GDP data achieved positive growth of 0.1%, exceeding expectations of zero growth.

The Conference Board's Surprise Index (measuring data performance relative to expectations) is now at its highest level in over a year.

On Tuesday (August 5), we will receive the PMI data from multiple European countries, which may continue this optimistic trend. The stable outlook for eurozone interest rates also reflects in the volatility index.

The implied volatility of the 10-year euro government bond yield has dropped to its lowest level since 2022 and is still trending downwards strongly.

As for short-term yields, there is limited uncertainty ahead, especially compared to US rates. Although the correlation between European bond yields and US Treasury yields has significantly decreased since Trump took office, US developments remain a key risk factor affecting our outlook. For example, if the US faces a rate hike level, it will be difficult to see eurozone interest rates rising.

On the other hand, if inflation and issuance pressures push up US Treasury yields again, this would provide support for 10-year euro interbank offered rates (Euribor) to break above 2.8% later in the year.

(Euro-dollar daily chart, source: Huitong) Beijing time 14:12, euro-dollar currently reports 1.1546/47.