EUR/USD: German yield curve may turn negative on trade tensions and cap upside in Euro

EUR/USD is better bid at press time, but the upside looks limited or the gains could be short-lived, as escalating US-China trade tensions are likely to push the entire German bond yield curve into the negative territory.

The currency pair is currently trading at 1.1126, representing 0.17% gains on the day, having charted a bullish candlestick pattern over the previous two trading days.

The uptick could be associated with the market narrative that the US Federal Reserve may deliver additional rate cuts of 50 to 75 basis points before the end of the year if the US-China trade tensions do not subside. The US central bank cut rates by 25 basis points last week but refrained from signaling further easing. 

Trade tensions escalate

Reports hit the wires in Asia that China has asked state buyers to halt purchases of the US agricultural goods. Beijing's move has come four days after President Trump said that the US will impose 10% tariffs on $300 billion worth of Chinese goods from Sept. 1.

With the situation on trade front worsening, investors may feel tempted to offer US Dollars. However, it is worth noting that escalating trade tensions could lead to a German recession.

The nation's bond market is close to turning negative. On Friday, Germany's 10-year Bund yield slipped to a record low of -0.501% - well below the European Central Bank's deposit rate of -0.40%.

More importantly, as of Friday's close, German bunds are offering negative returns (yields) across all maturities except the one maturing in 30-year. That bund is offering a yield of 0.008%, but will likely find acceptance below zero later today.

With that, the entire German yield curve will drop into the negative in the EUR-bearish manner.

Final readings for the German and Eurozone services PMIs for July are scheduled for release today. The data, however, could be overshadowed by the slide in China's Yuan, the resulting risk aversion and the developments in Germany's bond market.

The focus may shift to the US ISM Non-Manufacturing PMI (Jul) scheduled for release at 14:00 GMT.

Technical levels